Did the Trump Tax Cut Actually Work?
First of all, the intent of this piece is not to argue that Trump is a good or bad President or even a good or bad person. It’s strictly looking at the impact of last year’s tax reform legislation formally known as the Tax Cuts and Jobs Act of 2017 aka Trump Tax Cuts. Are we on a path toward prosperity or doom?
There has a been a lot of press about the high budget deficit that the Federal government has for 2018, $779 billion; a $113 billion year over year increase. The general assumption is that this is due to the Trump Tax Cuts that went into effect in 2018. But is that really the case? What has been the affect of those tax cuts?
Most people would be surprised to learn that US Federal revenue hit a record high in 2018. How is that possible you say? Didn’t Trump lower personal income taxes, capital gains taxes and significantly lower corporate taxes? Yes to all of those but Federal revenue still went up in 2018 by .5%. The increased economic growth more than compensated for the reductions in the tax rate. The Federal government receives most of its revenue from taxation which is a multiple of tax rate times income of constituents. In this case the tax rate went down but the income went up enough such that the resulting revenue actually increased.
There is always dispute about what the right tax rate should be. If you want to maximize government revenue, you need to find a tax rate that motivates economic activity but is high enough that the government benefits from the increased scale and growth. You can do a thought experiment on this to better understand. If the tax rate was zero percent, the government would get no revenue. Likewise, if the tax rate was 100% there would be no incentive for anyone to work or create and run businesses and the government would also make no revenue. Therefore, the right tax rate to maximize revenue clearly falls somewhere in between. The real debate is what the right tax rate should be i.e. a higher rate doesn’t necessarily equal increased government revenue.
Last year during the debate about the tax reform bill, we heard a lot about how the tax cut was going to cost almost $12 trillion over the next decade. These numbers were based on the assumption that the economy wouldn’t grow enough and therefore a reduction in tax rate would result in lower Federal revenue. The proponents of the tax cuts argued that lower tax rates would stimulate increased economic activity which would more than compensate for the lower tax rate and in the process create more jobs. Has it done those things?
In addition to record Federal Revenue in 2018, we have record low unemployment of 3.7%. For years it was believed that full employment in the US was at an unemployment rate of 6%. This increased employment is one of the sources of increased revenue. FICA tax (paid by employers and employees as part of worker payroll) collections rose more than 3% in 2018. Individual income tax revenue is actually up about 6% in 2018. This is from a combination of the increased number of employed individuals, salary increases, capital gains increases and growth in income for small business owners which has resulted in this increase in spite of a decrease in tax rates.
There is one component of unemployment that is not often thought of or discussed for some reason. Specifically, the reduction to the cost burden on government as a result of increased employment. Shifting people from government subsidies and income to business payrolls not only increases revenue collected from these newly employed individuals but reduces the social welfare costs that the government bears. These costs exist at both the federal and state level and show up in many forms beyond just unemployment benefits such as WIC (Women, Infants and Children food benefits). It is surprisingly challenging to find sources for how these numbers change with increased employment. Through a little extrapolation, one can get a sense for the scale of this though.
According to the PEW Research Center, the Federal government spent $513.5 billion on “Income Security” in 2016. The unemployment rate in 2016 was 4.9% versus 3.7% currently. That’s a 24.5% reduction in the unemployment rate. If we assume that Income Security costs followed this reduction, that would equate to a $125.8 billion reduction in federal cost for social welfare programs related to unemployment. Which is another way of saying that if a tax cut reduced federal income but created enough jobs to move people off the government dole saving an equivalent amount of money, that is still in the best interest of society. This assumes that people are happier, better off, have better long-term prospects and contribute more to society by being employed than being a ward of the state.
It is also worth considering the impact of reduced unemployment on the crime rate. According to research from Georgia Tech, a one percent increase in the unemployment rate will increase the violent crime rate by 14.3 per 100,000 inhabitants. In addition to the untold human suffering that results from crime, violent crime in particular, there are costs associated with property damage and theft as well as law enforcement and incarceration costs. All things considered, there is significant societal benefit from reducing the crime rate. So did the crime rate go down in 2018? According to a recent report from the Brennan Center for Justice, the 2018 crime rate is projected to be down by 2.9% in the US this year compared to 2017 and the murder rate is down 7.6%.
There is still an additional benefit of larger and growing economy and lower unemployment. People spend more money which helps to grow the economy and increase corporate incomes but also increases sales tax revenue. So did the tax cuts work in this regard as well? The answer would seem to be yes. Federal excise tax revenue jumped 13% in 2018. Sales taxes are collected at the state and local level; as of the end of Q2 state sales tax receipts were up about 2.4%. This varies widely by state with New Mexico’s state sales tax up 25.1% and Ohio’s down 5.1% through that period.
This leads to another effect of last year’s tax law which was not appreciated in consideration of the trade off between Federal tax rates and stimulating income to be taxed. States have greatly benefited from the new tax law as they didn’t have to reduce their tax rates but did see increased incomes resulting from the growing economy (remember government revenue is tax rate times constituent income). As a result, they are seeing the best of both worlds. According to the Wall Street Journal, 40 states surpassed their revenue projections for fiscal 2018. Personal income collections for states has grown by 7.9% and outperformed forecasts by 3.6%. As States provide a significant amount of services and share costs for some services with the Federal government, this increase in State revenue is truly a valuable dividend of last year’s Federal tax cuts.
The final element of this tax plan is the incentives for companies to repatriate overseas income and to encourage more US based business activity due to the more attractive lower corporate tax rate. There had been a steady flow of companies doing reverse mergers and other global tricks to avoid US taxation. Apple was really the poster child for the issue of holding money offshore and doing business offshore to avoid the then high US corporate tax rate. Last week Apple announced that it plans to invest $1 billion in an Austin, TX campus, creating 15,000 high paying jobs. Additionally, Apple is opening new locations in Seattle, San Diego and Culver City, CA with an estimated 1,000 new jobs in each of these locations. Apple said earlier this year that it will invest $30 billion in capital spending in the U.S. over five years, creating more than 20,000 jobs so this is certainly a strong first step in that direction. There have been numerous reports that the Trump administration has been “strongly encouraging” Apple to commit to increasing its U.S. footprint and workforce in light of the major corporate tax reduction. In either case, it’s safe to assume that last year’s steep reduction in corporate income tax rates was a direct factor in Apple’s decision to build out facilities at these locations. In addition, Amazon’s new HQ 2 in Virginia and NYC is expected to create 50,000 jobs and Google is planning on an additional 14,000 jobs in NYC alone. Today, Google announced that it too will be investing $1 Billion in its new NYC campus. Per the WSJ, “All three companies have been under pressure to show the huge profits they have generated are benefiting the U.S. economy more broadly.”
Going back to that large Federal deficit increase of $113 billion; how could it be increasing if Federal Revenue went up? As anyone who’s ever tried to balance a budget knows, there are two sides: your income and your spending. Indeed, the Federal budget (spending) increased by $127 billion in 2018.
It would be fair to say that we don’t know how much the economy might have grown without the tax cuts. Maybe with a higher tax rate, the Federal government might have made more revenue on somewhat slower economic growth. But then again, maybe not. And there are other benefits of increased economic growth in terms of decreased unemployment (and its decrease in associated federal program costs and societal costs) and increased wages. Additionally, a growing economy encourages R&D investments, creating the businesses and jobs of the future. It likewise encourages capital investments in new equipment, facilities, software, etc. which creates a fly-wheel effect by increasing revenues for the suppliers of those capital items who in turn hire more and increase wages which puts more money into the hands of consumers who buy more products and services and further grow the economy.
Last year’s tax cuts were certainly not perfect and may have a number of flaws and opportunities for optimization. But it is also true that they have largely worked as intended thus far. It remains to be seen whether 2018 represents a one time “sugar high” from the corporate tax reductions or whether the fly-wheel effect has really begun. All the tariff disputes have muted the economic expansion so far but if positively resolved, could help to extend economic growth through 2019. But tariffs will need to be the subject of a future article. Stay tuned…
Additional source on Federal Income: Investor’s Business Daily
