A Closer Look at Apocalyptic Predictions on Trump's Tax Reform

On December 20, Congress passed a historic tax reform and tax cut measure that was signed into law by the president on December 22.  Critics of this measure have been insisting that the reduction in taxes will exacerbate the deficit and long-term debt.  Nothing of the sort will happen, even though several members of Congress and even the CBO think it might. 

We can show via historical graphs produced by the Saint Louis Federal Reserve Bank that changes in tax policy and rates since 1929 have had little effect on the amount of money collected by the federal government as a percentage of GDP.  (See here.)

Put another way using historical data, it appears that the only thing that has a great effect on federal government receipts is GDP, not the type and rate of tax levied.  Thus, persons seeking to raise government revenues would be wise to do things that would promote GDP growth.  Since the probable effect of the tax reform and tax cut passed by Congress is an increase in GDP, it appears that those objecting are uninformed or disingenuous.

Moreover, while the tax reform that was enacted will improve economic growth and boost government revenues, it could have been even better in both respects.  First, and most importantly, the corporate rate should have been set even lower – preferably to ten percent or lower.  A zero corporate rate would pay bigger dividends in both growth and government receipts.  Corporations do not really pay taxes anyway.  Their employees, customers, and shareholders are the real payers of the corporate tax.

Second, the personal income tax was left too complicated.  Simplicity reduces compliance costs and lessens the drag of income taxes on economic growth.  Some politicians have insisted on some form of deduction or credit for state taxes, mortgage interest, child credits, and other pet causes.  All of these things complicate the tax and increase the compliance cost and the drag on economic growth.  Moreover, with the increased standard deduction, very few taxpayers will really benefit from these deductions.  When you hear the cry to insert this or that deduction or credit into the tax code, remind all around you that there will be a cost in terms of economic growth and government receipts.

Lets take this a step farther.  The Saint Louis Fed also published a chart showing the relationship between federal government spending and GDP.  (See here.)

From this chart we can see why there are deficits and government debt.  We can also see that Congress can prevent deficits and any addition to the debt by promoting GDP growth as noted above and holding spending to some percentage of GDP that is lower than receipts.

Since WWII, federal government receipts have averaged about 17% to 19% of GDP.  If Congress would insist that total outlays cannot be greater than 17% of GDP, there could be no deficit and no growth in the debt.  Picking a lower percentage of GDP would guarantee a surplus.

While we are on the subject of simple truths about taxing and spending, let's once again consider compliance costs and tax simplification.  Any tax provision that makes compliance more complicated costs the taxpayer more to pay his taxes and results in lower receipts for the government.  Therefore a simple, no-deductions flat tax is the best from a revenue and compliance point of view.

Many members of the House and the Senate profess not to know the simple facts presented above and increase spending on their pet projects rather than rein in total spending to match receipts as a percentage of GDP.  Moreover, since we have practiced spend, spend, spend for several years, we are now at a point where total outlays must be curtailed while outlays for some areas such as infrastructure and defense must be increased.  This will increase the desire of some senators and congressmen to make spending deals that will exceed the limits that must be met in order to stop budget deficits and additions to the already huge national debt.  For more on this subject, see here and here.

In the fall of 2018, we will elect or re-elect all of the members of the House and about one third of the Senate.  Will the voters make sure that the candidates for the House and Senate stake out a position on taxation and spending that recognizes the distinctions drawn above?  If not, why not?  Think about it.  Our security and prosperity and those of our children and grandchildren might depend on it.

Jeff Scribner is a retired Army officer and president of ASI Enterprises, Inc., an investment bank serving small and medium-sized businesses.  He can be reached at jscribner@asienterprises.com.

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