The USA is setting the wrong example on taxes

It has been pointed out by various authors (including myself), that President Donald Trump is making the US look ever more like a developing country. The current tax reform plans do so too. However, Trump is not that much to blame personally. His influence on what Republicans in the U.S. Congress are currently doing has been minimal. Republican senators and congress-people are acting in irresponsible manner befiting a banana republic.

So far, the Senate and the House of Representatives have both adopted bills of their own, which now must be merged into one. Both bills are designed to increase the national debt dramatically, exacerbate problems of inequality and do very little in terms of driving growth. The legislators have not assessed the options diligently, avoided the regular process that would involve Democrats in committees and kept interest groups with divergent views at arms length. They intend to use their slim majority of two votes in the Senate to ram through a reform that no one except themselves has any say in.

Republicans promise their tax cuts will trigger fast economic growth which will lead to such spectacular additional tax revenues that the tax cuts will ultimately pay for themselves. This promise has been made again and again. It neither came true when President Ronald Reagan reduced taxes in the 1980s nor when President George W. Bush did so 20 years later. More recently, it failed spectacularly when tested at the state level in Kansas. Republicans are basing essential legislation on wishful propaganda, not on serious analysis and even less on empirical evidence.

Ever since President Barack Obama first took office in early 2009, Republicans posed as deficit hawks who would do anything to ensure that the government did not spend too much. Now they plan to add up to $ 1.5 trillion to the national debt in the next 10 years. They claim that is necessary to boost employment. If businesses keep a greater share of their profits, they say, the owners will invest in expansions of existing companies or set up new ones, creating jobs.  Once more, this is hollow propaganda.

The US economy is currently close to full employment, and company profits are quite high. However, profits are mostly being invested in financial assets rather than new production capacity, which is one reason stock market prices are so high. Investors expand production facilities when they see market demand, not when they have lots of money in their accounts.

In times of high unemployment and low interest rates, deficit spending by governments can indeed boost employment. The reason is that additional people find jobs, earn money and thus increase consumer demand. However, when employment rates are good, as is currently the case, there are not many people who will re-enter the labour market and thus contribute to aggregate demand. While a sluggish economy, as the one Obama inherited from Bush, may need a stimulus, a strong economy is at risk of overheating. Higher government debt is likely to drive up interest rates, a trend which in turn depresses investment in productive facilities, which are typically credit financed.

During the election campaign last year, Trump claimed that the stock markets reflected a dangerous bubble, and that the increasingly good employment data was fake news. Today, he and his Republican friends are claiming that even hire stock market indices and employment figures are proof of the wonderful work they have done. The way the statistics are compiled hasn’t changed. Moreover, the new administration has not passed any major law so far, but it does keep shifting the goalposts.

Observers have pointed out many shortcomings in the Republicans’ reform proposals. I will not go into the details here, but when leading business papers express criticism of the planned tax cuts, you know something is going seriously wrong. The journalists who work there are not left-wing activists who hate investors.

A carefully worded editorial in the Financial Times stated: “Economically, the most important question is the effect on growth and investment of cutting the headline corporate tax rate from 35 % to 20 %. There are few certainties here. One is that the cut will increase the deficit by a large amount — at least $ 1 trillion  — over a decade. The idea that the cut would pay for itself has modest support in theory and none in history. (…) It must be noted, however, that the additional money will land in corporate coffers at a time when profits are already near all-time highs and many companies are flush with cash. Fixed investment is low despite this. Still higher profits may not change this pattern.”

An editorial in the Economist argued: “A lack of consistency makes Republicans seem unprincipled. They have spent the past decade claiming that the national debt is among their main concerns. In 2009 they opposed President Barack Obama’s fiscal stimulus, arguing that it was unaffordable. Yet it cost less than today’s tax bill would. It passed when unemployment was over 8 % and interest rates were stuck near zero. Today unemployment is 4.1 % and rates have started rising because the Federal Reserve is worried about inflation.”

The same editorial pointed out the president’s hypocrisy, moreover: “The whiff of self-enrichment does not help. President Donald Trump assures Americans that the bill will be ‘not good’ for his bank balance. Without seeing his tax returns, that is impossible to know. But he holds interests in around 500 ‘pass-through’ businesses, which are among the main beneficiaries of the tax bill.” His children, moreover, will one day benefit from the planned reduction or abolishment of the taxes that must be paid on huge inheritances.

The Economist’s most important point, however, concerned the lack of regular legislative order: “A robust and factual debate is essential to good policymaking. (…) Democracy requires deliberation, and deliberation requires honesty.”

This aspect cannot be overemphasised. This is an important point. The US tax system is extremely complex, and sloppy legislation is likely to create many new loopholes. It is safe to say that the current plans will have unintended side effects lawmakers do not understand today. It is dangerous to draft reforms in haste and try to pass them without proper public debate. Allowing the public to study draft legislation and inviting responses is an important way of avoiding mistakes. Democratic procedures for reasonable deliberation serve a purpose, and to bypass them expression of arrogance.

By the way, the bills that have been approved by the Senate or the House of Representatives respectively are not in line with what Trump promised on the campaign trail last year. The beneficiaries of the existing plans will not be the middle class and even less the people who are suffering the adverse impacts of globalisation. On the contrary, it is foreseeable that Republicans will now argue they must cut safety-net spending to rein in the debt. Orrin Hatch, a Republican senator from Utah, has already said that there is no money for extending a decades-old programme that funded health care for the children of poor parents.

All summed up, this is the kind of legislation we would expect from an arrogant autocrat in a poor Third World country. The elite will become still more privileged, and personal benefits accrue to the president and his family. Republican legislators are paying no attention to what resources the government needs to afford the services that must deliver. Even before they have passed their tax reform, Republicans have begun to argue that they have run out of money. Policy is not being made with an eye to the common good. No, what is happening is the reverse Robin Hood approach: take from the poor to give to the rich.

This is an attitude humankind cannot afford. The international community has spelled out a vision for a better future in the Sustainable Development Goals. To achieve them, we need capable, not minimal statehood. The notion that the smaller the government is, the better for society, is totally wrong. If it were true, the structural adjustment policies that were implemented in the 1980s and 1990s in developing countries would have  led to spectacular growth. It turned out, however, that investors are not excited about countries that are basically unregulated and lack public infrastructure.

This is evident in the US a itself, by the way. If the “government only causes problems” thesis was true, Montana or Wyoming would be the most dynamic and innovative states in the USA. They have huge territories and comparatively small governments. The US economy, however, is driven by high-tax and big-government states like California and New York. The truth is that markets thrive best when they are regulated competently.