Four Consequences if Republicans Fail on Tax Reform

By Sven Larson, PhD

The first half of 2017 brought good news: a tight job market, accelerating economic growth, and increasingly long-term business investments. President Donald Trump’s promises to repeal and replace Obamacare and pass major tax reform have injected an optimism into the economy the likes of which we have not seen since at least the Bush administration’s tax cuts in 2001 and 2003.

Now for the bad news: it could soon come to an abrupt end. Why? Call it Republican political inertia. After their chronic inability to move the needle on Obamcare reform, Republicans have now turned their attention to taxes.

That should be good news, but with the track record that Congressional Republicans have so far, it could turn out to be just the opposite. If so, the optimism that Trump has brought to the economy, will slowly but inevitably wither away.

The stakes are high. Trump wants growth-generating cuts to both corporate and personal income taxes. Naturally, he would hope to get that done by working with Republicans. The problem is that elephant of inertia, sitting right in front of the door to political deal making. Unless Republicans get rid of it, a growth-oriented deal on taxes seems increasingly remote.

Therefore, nobody should be surprised if he chooses to open a dialogue with Democrats. Here is where the trouble begins. Fox Business explains:

Democratic leaders oppose any tax cuts for high earners. A letter signed by 45 of 48 Senate Democrats declared that they were willing to pursue a bipartisan reform of the tax code — under the condition that the plan does not include tax cuts for the wealthiest Americans.

Any tax cuts are better than no tax cuts, but some tax cuts are better than others. The problem with the kind of deal Democrats would be comfortable with is that it would quickly bring to a halt the Trump economic surge and thwart any future positive effects of tax cuts. The reason is in the distribution of the cuts that Democrats would demand in order to get onboard.

As economist Walter E Williams explains, the top 10 percent of income earners pay 70 percent of all federal income taxes, while the bottom-50 percent pay as little as three percent. A Trump-Democrat tax deal would reinforce this imbalance, and that would have a number of bad consequences.

First: the more we tax high earners relative low earners, the stronger the marginal effects will be in our tax code. Fewer people will think it worthwhile to leave the large community of tax-free workers for the exclusive club of taxpayers. The fallout is fewer small businesses (whose owners file under personal income) and fewer jobs created by those that exist.

Second: when taxpayers are reduced to a special interest, they will have an incentive to lobby Congress for special treatment. The result: a tax code filled with lobby-created loopholes, exemptions, and other means to reduce the actual tax burden. What government gains in one end, it loses in the other.

Third: when there are more votes to be gained among tax-free workers than from taxpayers, Congress has a strong incentive to expand and create new entitlement programs. Government’s spending problem is perpetuated.

Fourth: the ideological argument that opposes cuts to high personal incomes is the same argument that will stop cuts to corporate income taxes. By the standard statist playbook, profits are evil; somehow, profits steal money away from workers and consumers. Since high incomes are also considered unfair — for much the same reasons as profits are evil — the progressive rim of the political spectrum is home to deeply rooted resentment toward any kind of tax cut for "the rich."

With a steeper marginal effect in personal income taxes and no reduction in corporate income taxes, the end result is clear: more economic stagnation, more deficit spending — and more debt for our children to inherit.

The only people who can secure a tax deal that is good for the future of the American economy are the Republicans in Congress. For that to happen, they would have to give up show-and-tell politics for get-it-done legislation. Is that too much to ask? Hopefully, no. But probably, yes.

Image: fibonnaci blue.

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