06/10/2017
During the last eight years, the United States has experienced the largest transfer of wealth from savers and the middle-class to the State in its history. $1.5 trillion in taxes, almost $10 trillion of new debt and $4.5 trillion of monetary expansion, for a GDP increase of $3 trillion.
The Obama Administration’s wrong fiscal policy meant the removal of more than 10% of the average household disposable income. Thus, it is not surprising the economic recovery has been the poorest in the last 20 years, with an economic growth below half of its potential.
The surprising aspect from the analysis of interventionist economists is that the same who welcomed the Hillary Clinton and Obama policy of more spending, taxes and deficit, today are horrified due to the tax-cuts because…they could increase deficit. It seems deficit is only good when they take money from our pocket, not when they give it back to us.
Trump’s fiscal plan has all the economic logic and it is also politically brilliant. As Jeffrey Tucker from the Foundation for Economic Education explains, it is a plan that boosts economic growth and consequently increases revenues. Moreover, voters perceive it directly.
It comprises three fundamental factors:
• Reducing the Corporate Tax rate from 35% to 20%. Currently, US companies have an effective tax rate of 23%, above the OECD average of 20%. Thanks to the reduction, tax competitiveness is recovered and inversion deals are stopped. That is the US companies’ relocation to other countries offering more attractive taxation, which Congress estimates that would reduce tax revenues by $18.5 billion between 2015 and 2024. Enterprises relocations are reduced while the cash flow of companies from other countries is attracted. The Obama Administration erroneous fiscal policy shot up those inversion deals and the multinationals quantity of money outside the US.
• Reducing capital gains tax rate from 23.8% to 20%.
• Reducing Personal Income Tax rate for all citizens to 12%, 25% and 35%, simplifying the brackets and increasing deductions to families. An improvement for the middle-class that did not happen since the eighties.
Maximum deduction per person is doubled and deductions for mortgage and family expenses are maintained. The Personal Income Tax cut means that citizens who earn less than $25.000 annually do not pay the Personal Income Tax, while citizens earning less than $75.000 pay only 10%, the ones earning between $75.000 and $225.000 pay 20% and the rest pay 25%, according to the U.S. Secretary of the Treasury, Steve Mnuchin.
The biggest tax cut in history would mean almost doubling lower-income groups’ current disposable income.
The World Bank estimates these tax cuts will strengthen growth and the Deutsche Bank considers they should also be taken by the European Union and estimates they could double real GDP growth in the United States.
There is a wide range of economic studies which prove the positive effect of tax cuts. The International Monetary Fund (IMF) analysis of more than 200 cases in 21 countries shows that tax cuts and spending reductions are much more effective in stimulating growth and prosperity than increases in public spending. Looking at specific cases, the studies of Mertens y Ravn (“The dynamic effects of personal and corporate income tax changes”, 2012), Alesina y Ardagna (“Large changes in fiscal policy, taxes versus spending”, 2010), Logan (2011) or the IMF conclude that in more than 170 cases the impact of tax cuts has been much more positive to growth and employment than other fiscal policies.
It has been proved that tax cuts have helped to increase revenue collection. Reagan’s tax cuts contributed to improve tax revenues in $80 billion in ten years. The Edelson Institute shows how tax cuts increased tax revenue thanks to the rise of economic activity with Kennedy, Reagan and the George W. Bush Administration.
According to the U.S. Secretary of the Treasury, Mnuchin, these tax cuts will pay for themselves and will mean a benefit of $1 trillion for the economy. Above all, they are relevant because of the importance of recovering the US anemic economic growth to a level closer to its potential, improving the participation rate in the labor market and unwinding the tax burden that enterprises and citizens suffered in the past eight years.
This tax cut includes an incentive to repatriate more than $2 trillion that the US enterprises have abroad. The policy has a very relevant impact both in the European Union and in the rest of the world. It is estimated that only the repatriation of capital from US enterprises towards the US could take away up to $95 billion from the EU, which continues in the wrong direction increasing tax burden and fining technological giants in the vain desire of collecting taxes at any price.
Nevertheless, the greatest impact is that, again, the European Union places itself further in terms of taxation oriented towards growth. There are many issues that can be criticized regarding Trump’s Administration, but here we are not talking about ideology or economic thought, this is common sense. If the US wants to remain in the lead of the global economy it must abandon the stagnation of productivity, investment and disposable income that has come from the assault on savers and productive sectors.
Tax cuts are not debatable as the driving force of the economy from a point of view of creating more wealth and non-confiscatory redistribution. And that is the objective, to recover the middle class who has paid for the excesses of the last eight years.
We still do not know whether this bill will pass or not since the Congress and the Senate are divided. Nevertheless, the important matter is to understand if it will improve growth, which is only being questioned by a few, and if it will help to reduce deficit. The Committee for a Responsible Federal Budget holds estimates showing that it does not increase deficit, Mnuchin estimates it actually reduces it, and the Trump Administration holds in its budget up to $45 billion as a financial cushion. However, the fact that these measures have been criticized “for increasing the deficit” by those who said it is necessary to increase borrowing (read “Time to Borrow” by Paul Krugman) shows they are on the right track.
The Trump Administration knows these measures will increase the global demand for dollars, exceeding supply, they support investment, employment and multinationals repatriation of capital as well as strengthen a middle class strangled by taxes. Mnuchin knows the increase of growth and disposable income will be very positive both economically and politically. Someday, in the European Union, we will understand that taxation needs to be oriented towards supporting enterprises and the middle class instead of using them as ATMs.
Daniel Lacalle, PhD in Economics. Chief Economist at Tressis SV. Author of Escape from the Central Bank Trap, among others.