Richard Epstein: Why Trump's Tax Plan Is Welcome
The Trump administration has revealed a one-page tax plan that, if implemented, could have vast consequences for the economy of the United States. The high points of that plan are simplification and repeal. The brackets go down from seven to three—10 percent, 15 percent, 35 percent. Corporate tax rates are slashed from 35 percent to 15 percent. The standard deduction is doubled to about $24,000, removing large numbers of low-income people from the rolls.
The alternative
minimum tax and the special Obamacare capital gains tax of 3.8 percent are
eliminated, along with the estate tax. Deductions for home mortgages and
charitable donations are preserved, but those for state and local taxes are
eliminated. The
plan has drawn enthusiastic support from conservative commentators and
withering criticism from Democrats. Where does the truth lie?
Any
successful system of taxation must juggle three separate ends. The first is to
impose as little drag as possible on economic productivity. The second is to
minimize compliance costs for both the government and taxpayers. The third is
to introduce some measure of distributional equity among taxpayers in light of
the diminishing marginal utility of wealth—an additional dollar of wealth
produces more satisfaction for the poor than the rich.
Very
few people flat-out deny this last proposition. If the total production of
goods and services could be held constant, virtually all people would prefer a
distribution that equalizes incomes across the population.
Unfortunately,
however, this is not the case, for the demand for redistribution is in deep
tension with the first two ends, which tend to reinforce each other. The full
analysis is complicated, moreover, because the resource effects of taxation
depend not only on who is taxed, but also on how tax revenues are spent.
One
reason why the Democrats find it so easy to tee off on Trump’s tax plan is that
they only evaluate taxes along a single dimension—redistribution from rich to
poor. Why else would the New York Times’ headline scream: “Tax Overhaul Would
Aid Wealthiest”? But that thinking suffers from two grave defects.
First,
it assumes that the major impact of changes in the tax law is redistributive.
In the words of Democratic Senate minority leader Charles Schumer, the Trump
plan is “a giant giveaway to the very, very wealthy that will explode the
deficit.”
The
only sensible debate asks how much growth comes from any given tax cut. So the
size of the cut matters. Cut taxes down to zero and there are no public goods
at all. But Schumer is also wrong to insist on some necessary link between tax
cuts and deficit increases, given that it is always possible to cut
expenditures, especially transfer payments and regulation, down to the levels
of a decade ago.
Indeed,
people are sensitive to small variations in taxes. The differential tax rates
among the various states, for example, have resulted in major business and
population movements across state lines from high tax/high regulation
jurisdictions to low tax/low regulation ones. Thus the Trump tax cuts could
help produce the economic growth he wants. Indeed,
if rightly implemented, his program could make the United States a more attractive
place for foreign investments, which in turn might walk Trump back from his
suicidal impulse to withdraw from NAFTA and erect trade barriers.
The
second major flaw in Schumer’s tax-giveaway argument is that it assumes the
current rates of relative taxation are correct, no matter how steep the current
ones skew. That argument thus introduces a ratchet effect, in which all tax
increases on the rich are lauded, and any tax cuts in their favor are
denounced, not with standing the general success of the Kennedy and Reagan cuts.
Over-taxation
of the rich, on this view, becomes a contradiction in terms. The 2001 round of
Bush II tax cuts did little good because they were phased in too slowly. The
2003 round, cutting capital gains, did far better. The
correct analysis does not sanctify the status quo ante, but looks to define
some independent normative baseline.
I
have long believed that a flat tax with a single bracket is the most socially
advantageous. It eases tax administrative costs. It reduces the impulse for
well-heeled people to split wealth among and within families through complex
trust, partnership and corporate arrangements.
It
reduces political intrigue by making it difficult for interest groups to stick
their opponents with heavy taxes, like the ill-conceived special taxes on
capital gains and medical devices used to fund Obamacare. And it imposes
constant political pressure on Congress to lower overall expenditure rates, now
that no one is exempt from taxes.
In
this regard, the Trump proposal, with three separate brackets, does not go far
enough. Likewise, there is a case for removing, not lowering, capital gains
taxes.
The
capital gains tax slows down the shift in wealth from less to more productive
uses. Set the capital gains rate at 20 percent, and any new investment of the
gains has to receive a 25 percent higher return than the existing investment to
produce the same after-tax return.
Thus
if the current $100 investment yields 10 percent, the new $80 investment has to
yield, net of transaction costs, 25 percent more—12.5 percent. Only then does
the taxpayer get the same rate of return (0.1 x 10- = 0.125 x 8)—for the switch
to make sense.
At
the very least, a better strategy is to allow a person to escape capital gains
taxes by reinvesting the gains from the earlier transaction in the market. The
increase in dividends and wages should go a long way to offset the losses.
First,
a plan that takes a long time to go into place will have little effect in the
short run, given that the tax benefits are only realized down the road.
Second,
these long-term gains may never be realized at all because the next
administration could easily decide to undo the reforms before they are fully in
effect.
The
combination of these two drawbacks is not lost on private investors, who will
discount the tax relief to take into account both the delay and the
uncertainty.
Trump’s
tax plan is not perfect. But it does chart a course toward tax reduction and
tax simplification, both of which are long overdue. The hard question is
whether a more concrete plan will make it into law. In
addition, Trump is surely correct, as a matter of first principle, to ditch the
estate tax. Like other wealth taxes, the estate tax is a tax on savings that
discourages long-term investment.
Worse
still, the effect of the estate tax depends heavily on the age of death: A
person who dies at 60 pays a tax well over one hundred times larger than that
of a person who dies at 90, who—in addition to delaying the tax—can also use
the 30 years to consume or give wealth away.
Trump
is also correct to keep the charitable deduction, which spurs decentralized
giving with implicit matching government grants. Finally, he is right to
eliminate deductions for state and local taxes, which require citizens in low-tax
states to subsidize the higher level of government expenditure in high-tax
jurisdictions. But
he has wrongly yielded to political pressures by preserving the home mortgage
deduction, which is an unwise subsidy to home ownership that invites another repetition
of the 2008 mortgage meltdown.
On
virtually all points, then, the Trump proposal pushes the ball in the right
direction. But what about its brief form, which many find embarrassingly light
on plan details, economic documentation, and phase-in rules?
On
balance, these shortfalls can easily be corrected in future iterations. It
doesn’t matter exactly how the Trump plan draws its three brackets. Little
turns on the difference between the 10 and 15 percent bracket. The 35 percent
jump (which is too high) is not that critical either.
Realistically,
the top incomes for the first two brackets will come in around $35,000-$70,000
and $150,000-$300,000, respectively. These numbers will be of little
consequence to people with taxable incomes over $1 million. Most economic
documentation is largely a fog of words, given that most forecasts tend to
overrate static and underrate dynamic elements.
In
many ways, the really critical element is the timetable for the phase-in of the
various reforms. On this score, there are two big risks in introducing any
serious program of tax reform by degrees, as happened with the first round of
the Bush II tax cuts.
Bold : If Clause
Red : Present Tense
Blue : Present perfect tense
SOURCE: www.newsweek.com
