Saving America from Trump’s tax reform

US President Donald Trump and congressional Republicans had anopportunity – and a responsibility – to reform the US tax code toaddress three major economic challenges: slowing growth, risinginequality, and a looming fiscal crisis. Sadly, they shirked their responsibility by passing a bill that squandered this opportunity. At a time when US public debt as a share of GDP is already at a post-warhigh, the legislation will add another $1.5-2.2tn to the deficit overthe next decade. At a time when income and wealth inequality is soaring,an estimated 80% of the tax cuts will go to the top 1% by 2027. And at atime when the economy has been growing steadily for 33 quarters and isapproaching full employment, the legislation will have only a modesteffect on growth.To be sure, a significant cut in the corporate tax rate was longoverdue. The legislation will likely stimulate investment and encouragedomestic and foreign companies to do business in the United States. But,by an overwhelming majority, economists predict that the increase inthe growth rate will fall far short of the annual gain of one percentagepoint (or more) hyped by Trump and his economic advisers.Moreover, there is no credible evidence to support the Trumpadministration’s declaration that the trickle-down benefits of fastergrowth will “increase average household income in the United States by,very conservatively, $4,000 annually.” A large body of economic researchshows that, at most, 20-25% of the benefits of corporate tax cuts willaccrue to labour; the rest will go to shareholders, about one-third ofwhom are foreign. The biggest beneficiaries will be the top 1% ofdomestic households which own about half of outstanding shares.Nor is there evidence to support the administration’s claim that thelegislation will pay for itself. As many of those who voted for it wellknow, the expected gains in growth will yield at most about one-third oflost revenues. But they are playing a cynical game. By reducingrevenues now, they will be in a position to justify cuts to servicesbenefiting lower- and middle-class Americans down the road – all in thename of “fiscal responsibility” and “entitlement reform.”Worse yet, the tax legislation is riddled with provisions that willdramatically increase inequality and limit economic and social mobility.By cutting the top income-tax rate, doubling the threshold at whichinheritances are taxed, and lowering taxes on pass-through businesses,the legislation amounts to a handout for the wealthy, paid for by themiddle class and future generations.The legislation also prioritises investment in physical and financialcapital over what the US really needs: more investment in human capitaland lifelong learning to help workers and communities cope with thedisruptive effects of automation and artificial intelligence. Instead ofexpanding the earned income tax credit to encourage work, thelegislation will, for the first time in American history, impose ahigher tax rate on employment income than on income earned byproprietors and partnerships. In addition, the legislation is an unabashedly partisan attack onDemocratic-leaning states and cities. For example, the bill imposes anacross-the-board limit on mortgage deductions, which will have adisproportionately adverse effect on people living in high-costDemocratic strongholds such as New York and California. Currently, themedian price for a home in San Francisco is $1.5mn; in Kansas, areliably Republican state, it is $187,000.And if that weren’t bad enough, the bill intentionally penaliseshigher-tax states like California and New York, by capping the federaldeduction for state and local income and property taxes. Ironically,this provision will hurt growth, by raising the marginal tax rate onmillions of workers in the country’s most productive locales andindustries. And it will make it harder for state and local governmentsto finance necessary investments in innovation, infrastructure, andhigher education – investments that are largely the states’responsibility but are pillars of overall US competitiveness.A majority of Americans already recognise that the tax law is deeplyflawed and full of false promises. After failing to repeal theAffordable Care Act (Obamacare), congressional Republicans rammedthrough a complicated tax package that will please their wealthy donors,but disappoint many of their voters. Given the tax law’s unpopularity,it will be interesting to see what happens in the midterm congressionalelections this November.In the meantime, progressive federalists in forward-looking states andcities must get to work picking up the pieces of the wreckage thefederal government is leaving in its wake. Keep an eye out for the manyways states will re-orient their tax regimes away from income taxes, andtoward property and sales taxes, including on services, which accountfor more than 70% of economic activity but have traditionally been taxedlightly at the state and local level. In some states, there is even talk of reclassifying state taxes so thatthey qualify as tax-deductible charitable contributions. Similarly, somehave proposed replacing state income taxes with payroll taxes thatemployers can deduct at the federal level. Keep an eye out as well for asizeable increase in outcome-oriented state and local funding forefforts to reduce homelessness and reform the criminal-justice system.Owing to its high marginal income tax rates and constraints onresidential property taxes, California will likely be at the forefrontof fiscal innovation. Already, multiple reform proposals arecirculating, including a ballot initiative to amend Proposition 13 thatwould dramatically ease existing restrictions on commercial-propertytaxes. And with the Democrats in full control of the state’s government,measures to counteract the federal law are almost certain to beadopted.California Governor Jerry Brown, for his part, has called theRepublicans’ legislation a “tax monstrosity.” He’s right: it’s dreadfulpolicy. Other countries that have reduced taxes on mobile corporatecapital have paid for the cuts by increasing value-added taxes and taxeson carbon, dividends, capital gains, and inheritances. Trump and theRepublicans, by contrast, chose to cut taxes on both businesses andtheir owners, while blowing an unsustainable hole in the federal budget,exacerbating inequality, and imposing new burdens on the mostproductive parts of the country. Still, necessity is the mother of invention. For progressive federalistsin US cities and states – the laboratories of democracy – it is nowmore necessary than ever to step up and start innovating. – ProjectSyndicate* Laura Tyson, a former chair of the US President’s Council of EconomicAdvisers, is a professor at the Haas School of Business at theUniversity of California, Berkeley, and a senior adviser at the RockCreek Group. Lenny Mendonca, Senior Fellow at the Presidio Institute, isSenior Partner Emeritus at McKinsey & Company.