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Cutting Taxes to Increase Revenue- Politics, Perception and Facts

Once again, tax simplification and cuts are being debated. There is general agreement that the tax code needs to be simplified, but there are a lot of differing opinions and perceptions about how to do this. Moreover, the impact of tax policy is counter intuitive. This is further complicated by political considerations and comments by the media, politicians and so-called experts.

To get past the politics and perception, we need to look at the facts.

Lowering top marginal tax rates to increase tax revenue is counter intuitive and portrayed as a break for the wealthy. One would think that if you have higher taxes, you have higher revenues, yet this is not always the case. Certainly there is a point at which lowering marginal rates too much causes revenues to dip. However, there can be no disagreement about how lowering personal marginal rates in the past has increased revenue and GDP.

There is bipartisan agreement that the corporate tax rate is too high. The sticking point with cutting the corporate rate is disagreement on what else this may be tied to and what to do with funds that have already been earned but are offshore.

The other factor that is being debated, primarily along political lines, is that lower tax rates can increase the growth of the economy, and  therefore the government actually takes in more dollars. This has been shown to be the case, so the only reason that some want to debate this is political.  Essentially as tax rates go down the government is getting a smaller piece of of a larger pie. Just the prospect of lower taxes has helped GDP growth increase since the election in 2016.

Just over a year ago, on September 25th, 2016, Donald Trump spoke at the Economic Club of New York. He joined the ranks of John F. Kennedy and Ronald Reagan in espousing a plan of reducing marginal tax rates for both individuals and corporations.

JFK’s Tax Cuts Increased GDP in the 1960s

On December 14, 1962, then-President John F. Kennedy unveiled a tax-cut plan to revive the long-stagnant U.S. economy in a speech at the same Economic Club. President Kennedy proposed lowering marginal tax rates for all taxpayers and reducing the corporate tax. He advised lowering the top tax rate from 91 to 65 percent and closing tax loopholes. He understood the counter intuitive nature of this plan, stating, “In short, it is a paradoxical truth that tax rates are too high today and tax revenues too low, and the soundest way to raise revenues in the long run is to cut rates now.” Then, as now, critics (and the uninformed) contended that lower tax rates would result in lower tax revenue. Then, as now, they were wrong.

In 1962, corporate rates were dropped. In 1964, Kennedy’s broader tax cuts were passed into law, after his assassination. In 1965, GDP grew by 10.7 percent and in 1966 by 7.99 percent.[1]

Reagan’s Tax Cuts Grew the Economy in the 1980s

By the late 1970s and early 1980s, we were once again faced with high unemployment and, paradoxically, also high inflation—so-called “stagflation.” Ronald Reagan acknowledged many times that he was following in Kennedy’s footsteps in proposing, and ultimately cutting, personal tax rates from 70 percent to 28 percent. He also cut corporate taxes and closed numerous loopholes. Once again, the American economy grew, unemployment went down and the broader equity markets moved up. Critics had claimed these cuts would be a break for the wealthy (as today’s critics also claim) and that they would reduce tax revenue. Once again, they were wrong.

According to U.S. Treasury statistics, The Tax Equity and Fiscal Responsibility Act of 1982, also known as TEFRA, increased revenues by $130 billion in its first four years. The bulk of these revenue increases came from the wealthiest Americans. In 1981, when the top marginal rate was 70 percent, the top 10 percent of income earners paid 48 percent of all income tax, and the bottom 50 percent paid 7.5 percent of all tax (source: Joint Economic Committee for the US Congress report, 1996).

President Trump’s Tax-Cut Plan Should Benefit the Economy

Currently the top 1 percent of income earners in the United States are paying 49 percent of all taxes, and the top 10 percent of earners are paying 82 percent of all income tax.[2] There is a limit to how much more the government can tax the top 1 percent to 10 percent of earners. The tax system is already unduly progressive, and there is only so much the government can take without hindering growth further. Increasing taxes thwarts economic growth and entrepreneurial spirit, whereas reducing taxes can accelerate growth and ironically shift the tax burden from low- and middle-class earners to higher-income people. Donald Trump set a goal of 4 percent economic growth, which would double the rate of growth over the past 15 years. Critics called the growth goal unrealistic and the plan a break for the wealthy. We have seen that a 4 percent growth rate is not only possible; when looking at the impact of previous cuts, we believe this figure may be very conservative, especially when combined with decreased regulation, which stimulates economic growth. Because a number of so-called loopholes are closed in all plans being proposed, lower- and middle-income tax payers would likely  see a reduction in taxes, while the bulk of the taxes are paid by the top 1 percent to 10 percent of income earners. The ultimate goal is to help all Americans, especially those who have lower incomes. The centerpiece of the Trump plan is a reduction in business tax rates for large and small firms, to 15 percent from the current uncompetitive 35 to 40 percent. He offered a 10 percent repatriation rate to incentivize American firms overseas to bring $2.5 trillion home. While we believe the actual rate will be somewhat higher, we believe that the corporate rate will be reduced and that this will greatly benefit the economy and country. An article in the National Review indicates similar optimism in Trump’s plan. The article states, “While such large cuts would lead to an immediate revenue shortfall, the difference could be at least partially made up by eliminating damaging deductions and exemptions in other parts of the federal tax code. A corporate rate cut could also be expected to broaden the tax base, further offsetting its own costs by spurring more investment, the repatriation of profits, the relocation of business headquarters… Cutting the corporate-tax rate in itself will increase GDP, and evidence suggests it will lead to higher wages for workers, too.”[3] Once we move beyond politics and perception and look at the facts, it is clear that cutting taxes helps the country, especially lower- and middle-income Americans. Regardless of which plan you believe in, there is no question that the top 10 percent of income earners are paying more income tax than ever before, both in terms of dollars and total percentage of taxes being paid. Finally, generating revenue is only half of the issue. The other part is what the government spends. Less than 15 percent of the government budget is for discretionary spending, and more than 65 percent is for entitlements such as Medicare, Medicaid, Social Security, welfare, etc. At some point, the government is going to have to look at these items and make some tough decisions.  But that’s another discussion.

Join Us for a Tax Legislation Review at Breakfast on January 13th, 2018 

We will be reviewing actual tax legislation at our 22nd Annual Resource Breakfast on Saturday, January 13th, 2018. You are welcome to join us, without cost or obligation, to hear about the new tax rules and a number of other timely topics such as cybersecurity.  To RSVP just give our office a call (440) 974-0808 or click here.

We Are Here to Help You on Your Financial Journey

Our role at Carver Financial Services Inc. is to help you prepare for whatever may transpire with taxes, the economy, benefits or otherwise. We are here to help you achieve your personal vision for the future and your life, whatever that may be. Change is always difficult and is often politicized. This can present an opportunity for those who are informed and prepared.

We are always happy to meet with you to discuss your vison and wealth planning — without cost or obligation. Each person’s needs and objectives are unique; therefore, your planning should be as well.   This is a dynamic process as regulations, the economy and your needs change.

We appreciate the opportunity to be your partner on this interesting journey. Please contact us whenever we may be of service at Randy.carver@raymondjames.com or (440) 974-0808.

__________

The information contained in this blog does not purport to be a complete description of the securities, markets, tax rules or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Randy Carver and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk, and you may incur a profit or loss regardless of strategy selected. Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members.
[1]. “U.S. GDP Growth Rate by Year,” http://www.multpl.com/us-gdp-growth-rate/table/by-year.
[2]. “Fairness and Tax Policy,” Joint Committee on Taxation, March 2015, file:///C:/Users/Libbye/Downloads/x-48-15%20(2).pdf.
[3]. Ryan Bourne, “Evidence Suggests That Lower Corporate-Tax Rates Increase GDP and Boost Worker Wages,” National Review, September 27, 2017, http://www.nationalreview.com/article/451811/corporate-tax-cuts-benefit-ordinary-workers.

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