Recently I was asked about my views on the Congress Bills passed this past weekend. To sum it up, I think it’s economically wise, but politically/realistically debatable.
I can well picture a group of UChicago economists sitting together — some of whom have taught me this past summer — applauding these tax reforms that finally put their theory into practice.
First off, the reduction of corporate tax from 35% to 20% is a big hip-hip-hooray for macroeconomists. Corporate-running is fundamentally investment, and corporate tax is a cost when calculating returns. Lower corporate tax increases incentives for investment, bringing more capital gushing into the economy. In fact, the Dow Jones just peaked earlier this week, reflecting investor’s confidence.
Some would argue that this reduces America’s tax revenues. I argue otherwise. Tax reductions are essential in where corporates decide to set up. 20% from companies who now come back from other countries and pays tax in the US is better than no tax revenue from them.
Tax simplification as a whole is beneficial, especially according to the proponents of a flat tax rate like Mankiw in this paper. I believe that taxation is like trying to transport sand using a funnel: there will always be leakages like the costs of collecting taxes and related accounting expenses. The House Bill simplifying the process from 7 to 4 tax brackets reduces unnecessary “spills” and preserves society’s wealth.
Particularly, numerous benefits to middle-class family bolster the economy. Their tax reductions increase spending because their marginal propensity to consume (what percentage of their additional earning do they spend) is typically higher than wealthier people. This means that each $1 more in middle-class income equates to more spending in the economy. Bravissimo!
These are so many other things to the economic side of the equation: The Laffer Curve; The Trickle-Down Theory; Supply-Side Policy, just to name a few. But what about realistically and politically? I think it’s a risky gamble, but the outcomes are worth the bet, just like the 1986 tax reform under the Reagan Administration. However, it’s still too soon to tell whether or not this bill will triumph before the government runs out of its budget.
In my opinion, politics is, in essence, economics. Different parties are only trying to convince others that their policy will be conducive to economic growth. Particularly, this is a decisive demonstration of the Republican approach. But economics is all about numbers — it doesn’t consider feelings of justice or fairness. Does it make sense for the rich millionaire to earn even more, while the miserably poor guy who already pays no tax sees no increase in his income? That’s a whole new aspect to consider, and one that can't be answered by economics.
If this does turn out optimistically, as I hope, Republicans win the political battle, and everyone wins the economic struggle. So fingers crossed!