Cutting corporate taxes is good economic policy—if done right.
NO MATTER whether the current Republican tax effort comes to pass, it will be clear the party of low taxation has forgotten how to cut taxes.
The Tax Cuts and Jobs Act, as their tax-reform bill is called, is sold as the apotheosis of Reaganite conservatism. Rubbish. The bill is an explicitly political piece of legislation—in the sense it aims to fulfill political, not policy, objectives. Republicans seem not to mind that fact. A number of elected officials are on record saying the legislation is meant to appease donors.
Politics aside, the bill falls short as a piece of policy. It has a number of positive elements—the corporate tax cut being the best example—but also a litany of carve-outs and poor policy choices. Cutting corporate tax rates is a good idea. But three criteria must be met for that to be the case.
First, corporate tax cuts must be fully funded. The goal of lowering taxes on corporations is to lower the cost of capital for those entities which create jobs. But this can only happen if firms can be certain their tax liabilities will not waver in the future.
Financing a corporate tax cut through deficit spending creates uncertainty. Budget deficits, which represent annual increases in the national debt, must eventually be paid back. Will President Elizabeth Warren hike corporate tax rates to close a mounting deficit? Or will President John Kasich cut social spending? The nature of how deficits are repaid is inherently unpredictable, undermining the goal of cutting taxes in the first place.
Moreover, large deficits can inhibit economic growth over time. Since the U.S. Treasury must borrow money to run a deficit, the American government thus soaks up a substantial chunk of the money available in credit markets. This, in turn, increases interest rates in credit markets, reflecting an increased demand for loans. Unfortunately, that makes it costlier for private companies to borrow money for investment, dampening growth in the medium run.
For these reasons, large-scale deficit financing is only justifiable in times of recession—as a way to jump-start the economy. With unemployment just north of 4% and G.D.P. growth humming along nicely, that the Republicans want to jack up the deficit by $1.5 trillion is silly.
Second, corporate tax cuts should be financed by nixing distortionary loopholes. The American tax code is rife with deductions and exemptions tailor-made for a specific industry or interest group. These tax hiccups create perverse incentives, misallocate capital, and thereby hurt economic growth. The problem is that once such loopholes are in place, their staunch defenders will henceforth be immovable.
The best way to finance a corporate tax cut is, therefore, to close the loopholes. This is the intended meaning of “tax reform”—lower the rates, broaden the base.
The list of carve-outs that should go is extensive. The employer-sponsored insurance exemption, effectively a $235 billion subsidy for health-insurance companies, is the worst culprit. Nearly as pernicious is the mortgage-interest deduction, which is regressive and subsidizes risky borrowing. The Republicans are right to target the state and local tax deduction (S.A.L.T.), which allows New York and California to levy high taxes on the federal dime.
We’d like to see the corporate rate cut to 25%, roughly the level that could be achieved without long-term increases in the deficit by some estimates. This would finally put us in line with other O.E.C.D. countries, too. Long past time.
Third, corporate tax cuts must be accompanied with “full capital expensing.” This is the idea that businesses should be able to immediately deduct spending on capital investment—as opposed to spending on wages or dividends—from their tax bill. Currently, firms “depreciate” investments, deducting a fraction of the cost of capital spending over years or decades.
By creating greater certainty, full capital expensing is a huge boon to investment. No longer will firms have to wait years to ascertain the full tax benefit of their investment. Firms are able to invest, receive an immediate deduction for that investment, and invest again. Businesses which invest, grow. And a growing business needs more and better workers, creating jobs and boosting wages.
One couldn’t be blamed for assuming Republicans would get this. But their tax bill is a head fake. It enshrines in law full capital expensing—for five years. That represents a deep misunderstanding of the benefits of expensing. In the world of business, things change rapidly and unpredictably. By giving an immediate deduction on investment spending, lawmakers can provide certainty well into the future, bolstering firms’ long-term investment strategies. But if full capital expensing lasts only five years, many of its potential upsides will be squandered.
On balance, the bill is not worth passing. If the Republican tax-reform legislation incorporated the three mentioned elements, maybe we could support it. Even still, the bill remains highly regressive by eliminating the estate (or “death”) tax. To comply with Senate rules, it raises taxes for many starting in 2025. It includes new loopholes for so-called “pass-through” businesses. It punishes graduate students. It repeals Obamacare’s “individual mandate,” rubbing salt in the wound for already-unstable health-insurance marketplaces.
The bill may yet pass. Republicans will rejoice. But their victory is a Pyrrhic one. They are mucking up policies which are fundamentally sound, weakening the public case for them. We all pay the price for a rotting Republican Party.
12/12/2017 Correction: A previous iteration of this editorial asserted, “But if full capital expensing lasts only five years, then the investment climate [will] become more uncertain, not less.” That is an overstatement. The five-year expiration of full capital expensing does not itself create significant uncertainty, as firms will know precisely when it expires. The editorial has been amended to reflect this. Sorry.
