How the Republican tax bill compares with previous reformsOn December 9, 2017 by Zander
REPUBLICANS like to say that their tax bill, which passed the Senate on December 2nd, is the first tax reform since 1986. President Donald Trump likes to call it the biggest tax cut in history. Mr Trump’s claim is easily disproved (see chart). Yet the comparison with the law of 1986, passed under Ronald Reagan, is more curious. There is no doubt today’s bill, like the older one, contains significant reforms. But the differences between the two efforts stand out more than the similarities. They are not quite mirror images of each other—but they are not far off.
There are three main differences between then and now. First, the centrepiece of today’s bill is a cut in the corporate tax rate, from 35% to 20%. At first glance, this seems comparable to the change to the levy in 1986, when it fell from 46% to—after a brief delay—34%. Yet such was the volume of deductions that the 1986 reform swept away, that it in fact raised average taxes on businesses. Notably, investment incentives were sharply curtailed. Today’s bill expands them, allowing businesses to deduct the full cost of investments in the year they are made (until 2023). Many economists see these investment incentives as a powerful stimulus for the economy. Because the reform of 1986 weakened them, and also raised capital gains taxes, the Tax Foundation, a right-leaning think-tank, reckons it might have reduced economic growth—a remarkable possibility, given the esteem in which it is held.
Second, the reform of 1986 was more egalitarian. Again, this is not easy to spot. Reagan’s reform slashed the top rate of personal income tax almost in half, from 50% to 28%. By most accounts, this was the number Reagan cared about most. But a loss of deductions, and the rise in overall business and capital gains taxes, were countervailing forces. And lower earners got income-tax cuts, too. According to the Centre for American Progress, a left-leaning think-tank, the tax system as a whole reduced the Gini index, a measure of inequality, by 5% before the reform, but by 7% after it.
Today’s bill is sharply regressive, despite the fact that it barely touches the top rate of tax. That is partly because Mr Trump’s priority has been tax cuts for businesses, whose owners tend to be rich. True, the bill curbs some corporate deductions, such as a tax break for manufacturers, and another for debt interest. But these changes do not come close to paying for the size of the tax cut that Republicans propose. A look at the stockmarket, which soared as the bill passed the Senate, shows that most businesses can expect to do well.
The third difference between the bills is their cost. The reform of 1986 was revenue neutral. Today’s effort will cost $1.4trn in forgone revenue by 2027, or $1trn, once its likely effect on economic growth is taken into account, according to an official score of the Senate’s bill.
For that reason, the better comparison is to Reagan’s tax cut in 1981, which really does have a claim to be the biggest in post-war history. That bill, much like today’s, was sold on the basis that tax cuts pay for themselves. It contained big across-the-board income-tax cuts, and investment incentives for businesses. Over its first four years, it cost a mammoth 2.9% of GDP—or rather, it would have done, had lawmakers not spent the next few years reversing it in an attempt to get deficits under control. Between 1982 and 1985 lawmakers passed tax rises worth 1.7% of GDP, according to the Treasury Department.
Such an about-turn is very unlikely on this occasion. That said, the Senate bill’s cuts to individual income taxes are to be phased out after 2025, to keep the costs down. What is initially a tax cut for most lower- and middle-earners will turn into a tax increase, because of changes to how tax brackets will be adjusted for inflation.
Republicans last passed temporary tax cuts under George W. Bush in 2001 and 2003. Like the law of 1981, these contributed to growing deficits. However, they were not reversed. In 2013, under Barack Obama, they were mostly made permanent by a bipartisan deal, although taxes on top earners went back up. It is possible that, come 2025, Congress will implement a similar extension of the Trump tax cuts. If it does, their long-term costs will be greater. If it does not, the effect on inequality of today’s bill will be worse, because its business tax cuts are permanent.
The tax bill could yet change as the House and the Senate negotiate. For example, one part of today’s tax reform is its abolition of the deduction, from federally taxable income, of money used to pay state and local income taxes. Republicans tried and failed to eliminate this deduction in 1986, but it was spared by the efforts of representatives of high-tax states such as California and New York. Both the House and the Senate bills scrap it (while keeping a deduction for local property taxes in place). Republican representatives from California are mounting a last-ditch attempt to preserve the deduction, up to a limit. “There’s a lot of things that Californians are working on,” said Kevin McCarthy, the House majority leader. In November, 11 of the 14 House Republicans from California supported the tax bill. If they switched sides, they could potentially block it in the final vote.
That remains unlikely, because Republicans are desperate for a legislative achievement. But the threat demonstrates how difficult it is to take away tax deductions once they are granted. Reagan’s reform managed it in part because of bipartisanship: the bill was introduced in the House Ways & Means Committee by a Democratic chairman, and ended up passing the Senate with 74 votes. If Republicans succeed in passing a tax bill by Christmas, as Mr Trump wants, and without any Democratic votes, it will at least be an act of impressive political discipline.