The wisdom, "There’s no such thing as a free lunch," made famous by conservative economist Milton Friedman in 1974, is worth revisiting as public negotiations on the tax bill
The main course of the Republican’s tax plan is a corporate tax cut from 35 to 20 percent. Of the $1.49 trillion in net tax cuts over the next decade, the corporate tax cut accounts for $1.46 trillion.
In response, there’s been no shortage of fact free rhetoric completely devoid of quantitative analysis — from both sides. My aim is to carefully examine the claims of Kevin Hassett, chair of the White House Council of Economic Advisers.
Hassett has promised the corporate tax cut will grow annual wages for the typical household by between $4,000 and $9,000: 4.8 – 10.8 percent (all numbers cited are real – inflation adjusted). This is the foundation of President Trump’s "middle class miracle" and assumes workers reap benefits from economic growth ignited by the corporate tax cut.
First, some economics. A corporate tax cut, in theory, stimulates economic growth by increasing the after-tax return on capital and thus promotes private investment. Hassett expects the corporate tax cut will draw money that companies have tucked away off-shore back to the U.S. Directionally, there is merit to this. Lower taxes mean America should become a more attractive investment destination.
Increased investment drives demand for and productivity of labor, pushing wages up for workers. Shareholders benefit too through increased dividends and asset prices. Although estimates vary, the Joint Committee on Taxation and Congressional Budget Office (CBO), both nonpartisan, conclude workers and shareholders receive a 25 – 75 split respectively following a corporate tax cut (technical note: most economists agree that corporate tax cuts are not passed onto consumers through lower prices).
More money in worker’s and shareholder’s pockets leads to consumption which further increases growth — what economists call the multiplier." The International Monetary Fund (IMF) estimate that, for the typical household, the multiplier is between 1.75 and 4.1.
For middle to upper income households, who tend to save more, they find the multiplier is between 1.5 and 2.1. When shareholders obtain increased dividends and asset prices, workers also benefit through the multiplier. Given that the Council of Economic Advisers has not released their multiplier assumptions, for simplicity, I will use the same multiplier for shareholders and workers — the average of the IMF numbers at 2.4.
Now, some analysis – bear with me. Hassett’s lower bound prediction would result in annual wage growth of $500 billion materializing over the next eight years – $4000 for each of America’s 125 million households. To achieve $500 billion of wage growth, private investment will need to grow by an average of 2.9 percent per year (calculations, for those so inclined: U.S. private investment of ~$3.2 trillion grows by 2.9 percent for 8 years to yield investment growth of ~$834 billion; apply a multiplier of 2.4 to yield ~2 trillion of economic growth; and use a worker share of 25% = ~$500 billion in wages growth. In a significant concession to Hassett, the $3.2 trillion base investment number is likely too high as not all U.S. investors will be impacted by the corporate tax cut).
Hassett’s upper bound, an increase of $9,000 per household, would demand annual investment growth of almost 6 percent. That’s investment growth of $1.88 trillion – larger than the corporate tax cut itself.
Irrespective of political affiliation, Hassett's numbers are objectively ludicrous.
Private investment has grown at 3.1 percent per year over the last three decades. Hassett’s predictions are incremental to this. Therefore, to hit his lower bound, Hassett is asking us to believe that historical growth will almost double as a result of the corporate tax cut. To hit his upper bound, investment would need to sustain levels above those during the dot com bubble in the late 1990s. We know how that ended – bubbles burst.
All of this doesn’t even account for unequal distribution of any wage growth for workers that does occur. A corporate tax cut will flow more freely into an executive bonus than to the factory floor. Using the current distribution of labor income, for every $1 received by the typical household, the top one percent will receive over $8.50.
Companies may also simply accumulate profits following the tax cut. As reflected by recent share buy backs, many firms with profits tucked away overseas have hordes of cash sitting idle in the U.S. This money does very little to stimulate economic activity that benefits the middle class.
It would help Hassett and the Republican’s case if tax cut advocates, such as JP Morgan’s CEO James (Jamie) Dimon, made some specific commitments. How much will he invest? How many more workers will he employ? How much will he increase wages and which of his workers will benefit? Instead we get vague placations from Dimon – "I would hire more workers if Trump's tax reform passes."
Even with mere scraps on the tax plan menu, the middle class face significant risks due to the corporate tax cut. There’s no free lunch, remember? The budget deficit will immediately increase. Popular government programs that benefit the middle class will come under pressure, namely Medicare and Social Security.
With the economy becoming stronger, a larger deficit is also poised to place upward pressure on interest rates that will burden the middle class. Funding Trump’s $1 trillion infrastructure promise now looks increasingly difficult too. Using a gas tax to fund infrastructure, a proposal that’s already been floated by the White House, would hit the middle class hard and detract from potential benefits.
Don’t get me wrong — sensible corporate tax reforms should be pursued. For instance, revenue neutral declines to the corporate tax rate could be achieved by ending inefficient deductions and closing tax loopholes including by cracking down on tax havens.
In a worrisome departure from tradition, balanced tax advice would once have come from the objective analysis and steady hand of the Council of Economic Advisers. Instead, Trump and the Republicans are utilizing the Council’s deceptive analysis to make disingenuous promises to an already justifiably disgruntled middle class.
Without dramatic changes to the tax bill, Trump and the Republicans will be handing a free lunch to America’s rich and powerful. The middle class will be left to pick up the tab.
Matt Tyler has worked for the last decade across the private, public, and academic sectors. Currently he is focused on improving social services primarily working with governments to improve child welfare, criminal justice, and homelessness. Matt is a former management consultant where he supported executives develop and implement strategy working with large companies in financial services, telecommunications, manufacturing, postal services, and retail. Subsequently he worked as an economist for Australia’s foreign service and as a policy adviser to the Federal Australian Labor Party on economic and social policy. He holds a Master of Public Policy from the Harvard Kennedy School, Bachelor of Economics (Honors) from Monash University, and a dual degree in Arts (Psychology)/Commerce (Finance) from the University of Melbourne. He tweets as @matt_b_tyler. To read more of his reports, Click Here Now.
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