There Is No Economic Theory That Justifies the GOP Tax Plan

Mitch McConnell preparing to trickle-down on your leg and tell you it’s raining. Photo: Chip Somodevilla/Getty Images

Most liberal criticism of the Trump tax cuts has focused on the fact that Arthur Laffer was a false prophet, and supply-side economics is a superstition.

This makes sense. Republicans campaigned on a giant middle-class tax cut, but they’re pushing a plan that delivers the lion’s share of its benefits to wealthy business owners and corporate shareholders. To reconcile this apparent contradiction between their rhetoric and their policy agenda, GOP lawmakers have insisted that the middle class actually has an enormous stake in boosting corporate profitability — even if many middle-income Americans have no literal stake in that matter. Reciting the trickle-down gospel, Republicans have argued that reducing the cost of capital will turbocharge investment; and thus, economic growth; and thus, middle-class wages. If supply-side economic theory is demonstrably false, then the GOP has no politically viable argument for its agenda.

So, naturally, progressives have been eager to note that supply-side economic theory is demonstrably false. The Bush tax cuts failed to produce the growth that supply-siders promised. Kansas implemented Paul Ryan’s blueprint for utopia — and ended up with four-day school weeks, weaker growth than its (higher tax) neighbors, and, eventually, a GOP-led legislature voting to ditch the “red-state model.” Supply-side experiments in Oklahoma and Louisiana replicated these results. But one doesn’t even need to turn to these precedents to know that businesses will not spend their tax cuts as Republican economists predict: America’s leading companies have been explicitly assuring their shareholders that the Trump tax cuts will not trickle down (or, rather, not trickle down below them).

These are all important points; but in one sense, they’re irrelevant. Supply-side theory may be snake oil — but the GOP tax bill is straight-up sewer water. Which is to say: There is no economic theory that justifies the tax bill currently moving through the Senate, not even the “trumped-up trickle-down” kind.

America’s top conservative economists have tacitly admitted as much. Earlier this week, Robert Barro, Glenn Hubbard, Michael Boskin, and six other economists wrote a letter to Steve Mnuchin, informing the Treasury secretary that the GOP’s tax-reform plan would accelerate economic growth by spurring investment. But in order to reach this conclusion, these right-wing wonks didn’t merely rely on a discredited economic theory — they also posited a wholly fictional Republican tax plan.

The actually-existing GOP bill would add more than $1 trillion to the deficit over the next decade, even when one assumes supply-side growth effects. What’s more, that figure is based on the premise that Congress will allow the bill’s middle-class tax cuts to expire in 2026, even though most political observers — including the bill’s authors — assume the very opposite. If we believe Paul Ryan, then the Trump tax cuts will actually add more than $2 trillion to the national debt in the coming decades.

And yet, in their analysis of the Republican plan, Barro and his fellow supply-side economists “assumed a revenue-neutral corporate tax change.” This is probably because a deficit-financed cut (of this magnitude) would be likely to raise future interest rates — and thus, dampen the policy’s growth effects, according to classic, supply-side assumptions.

The actual GOP bill also aims to encourage capital investment by allowing corporations to immediately deduct 100 percent of the cost of new machinery, equipment, and other assets for the next five years. Once those five years are up, however, the deduction disappears.

And yet, the economists who wrote to Mnuchin assume that this “full expensing” deduction would be permanent.

This is probably because there is no coherent economic argument for enacting “full expensing” on a temporary basis (in fact, according to textbook economic theory, the expiration of such a benefit, combined with lower corporate rates, could plausibly discourage investment). Republicans did not include this expiration date because they thought it was good policy — they did so because they needed to save budgetary space for delivering massive tax cuts to wealthy individuals.

Finally, the tax legislation that Republicans are on the cusp of passing would deliver a massive tax break to “pass-through” businesses. And yet, the supply-siders who wrote to Mnuchin appear to have completely ignored this component of the GOP plan. This is probably because such a measure has little plausible public benefit — under any economic theory — and huge potential downsides.

Right now, American companies that are registered as corporations must pay the corporate tax rate. This means that the owners of such companies have their business earnings taxed twice — first, at the corporate rate, and then as personal income. But closely held companies are allowed to distribute earnings to their owners without paying the corporate rate (in other words, their profits “pass through” to the owners’ individual returns). Those earnings are then taxed only once, as individual income.

The ostensible point of this policy is to make life a bit easier for small, mom-and-pop businesses. But a company’s eligibility for “pass-through” status isn’t determined by size. Koch Industries and the Trump Organization are both pass-through entities. So are most hedge funds. The very existence of such giant pass-throughs is, essentially, a giant loophole in our tax code. Few conservative economists would argue that it benefits the American economy for Donald Trump’s company to pay no corporate income tax, while other, similarly sized companies do.

And virtually none would claim that it’s important for Trump’s personal business income to be taxed at a much lower rate than his employees’ labor income. But this is exactly what the Republican tax plan would do. Remarkably, multiple GOP senators are actually arguing that their bill is unfair to millionaire business owners who evade corporate taxes by structuring their companies as pass-throughs — because the bill only gives such individuals a very large tax break, instead of an enormous one.

But what makes the pass-through deduction truly indefensible — from any economist’s viewpoint — is that it will create enormous opportunities for tax avoidance. If the GOP bill passes, high-paid professionals will have a huge incentive to reclassify their labor income as business income — say, by incorporating as an LLC and then “contracting out” their “services” to an erstwhile employer (it’s true that the GOP bill does try to solve this problem with a bunch of complicated restrictions, but most experts believe these will be all but unenforceable). This loophole will likely make the Republican tax plan even more expensive than conventional analyses are projecting, while also increasing the amount of money spent on tax (avoidance) attorneys and consultants in the American economy.

In sum: The Republican Party’s official tax “reform” policy involves adding trillions of dollars to the deficit; creating a huge disincentive for corporations to make any capital investments five years from now; rewarding the millionaire owners of tax-evading businesses with a special tax break; and delivering a massive stimulus to the tax-avoidance industry.

This makes sense as a plan for redistributing hundreds of billions of dollars to corporate shareholders, the Koch Brothers, and the Trump family, without running afoul of the Senate’s budget rules. But it is indefensible as a macroeconomic policy. And conservative economists know it — a rising tide might lift all boats, but a tsunami of sewage surely won’t.

There Is No Economic Theory That Justifies the GOP Tax Plan