Trump’s tax plan is out and low-income Americans are the winners

The Trump/GOP tax plan, released Thursday, has rightfully put tax reform at the forefront of public debate. Unfortunately, much of the discussion has been based on what the renowned Austrian economist, Ludwig von Mises, called the politics of envy. Rather than focusing on the effect the reform will have on the amount of innovation and economic activity that will benefit the vast majority of Americans, it has been bogged down in questions about how much of the tax rate reduction will go to “the rich.”

{mosads}Let’s focus first on what matters to low-income America—how they can have improved job opportunities and goods and services. The American economy has been mired in what an economist friend of mine has called a “plow horse economy.” Rather than a normal 3 percent growth rate, the economy has expanded at roughly a 2 percent annual rate. This dampened economic growth has been due to a combination of excessive government regulation and a tax policy that reduces the incentive to innovate, invest, and produce.

As an example, the United States has the highest corporate income tax rate in the industrialized world. The federal rate is 35 percent and the average state rate is 3.9 percent, for a combined rate of nearly 39 percent. The worldwide average is about 22 percent. This means that for every dollar that a company like Ford earns in the US, only 60 cents is available to reinvest in factories or research and development. If Ford earned that income in Ireland it could invest 87 cents in an Irish factory.

Trump backs House GOP tax bill https://t.co/0x8Tm9mEOz pic.twitter.com/XdAQChnrnk

— The Hill (@thehill) November 2, 2017

Lowering the corporate income tax rate to the global average, 20 percent at the federal level, would increase the incentives to create new products for everyone and to expand job opportunities. Eliminating the broad range of deductions that complicate the tax and benefit those companies with good political connections should also be part of the plan.

The same approach should be used with the personal income tax. Nearly all economists would agree that the best tax system has a broad base and low marginal rates. That means getting rid of the various deductions and credits that exist to encourage us to do what those in political power wish us to do. The lower tax rate will encourage entrepreneurs to take on the risk of innovating, since they will not have to share as much of their success with the federal government. The Trump plan would move tax policy in this direction.

Will there be a large increase in the deficit due to a plan that reduced rates and expands the base? First, it is useful to keep in mind that even if the projections of a $2 trillion addition to the deficit over a 10-year period hold, this is about $200 billion per year. The federal government is spending over $4 trillion per year, so even these high estimates have to be kept in context. In addition, total corporate income taxes are only 9 percent of the federal revenue, so reducing its rate provides a large economic benefit with little threat of reduced government revenues.

Rubio: GOP tax bill doesn’t do enough to help working families https://t.co/BMbmuYZAoH pic.twitter.com/p8G3YKHfsy

— The Hill (@thehill) November 2, 2017

Second, economic behavior will change once you have changed the incentives to innovate and expand production, and this will provide more revenue from the broader base. As Martin Feldstein of Harvard University pointed out on the 25th anniversary of the Reagan tax reform that lowered marginal tax rates and expanded the base, “the actual experience after 1986 showed an enormous rise in the taxes paid, particularly by those who experienced the greatest reductions in marginal tax rates.”

Finally, any reduction in income taxes must provide a greater tax cut to those who are wealthier. The top 1 percent of income earners pay 38 percent of the income taxes. The top 50 percent of income earners pay 98 percent of all income taxes. It is impossible to cut income taxes and not reduce taxes on the upper half of the income distribution. Asserting that a program is bad tax policy because the rich benefit from the tax cut is just silly.

While the details of the Trump Tax plan can surely be debated, its general thrust — reducing the marginal rates and broadening the base — will benefit low-income Americans by providing both more job opportunities and a broader range of goods and services. It will also expand our freedom by reducing the ability of government to direct our economic activity in the direction most preferred by those in power.

Gary Wolfram is the William Simon Professor of Economics and Public Policy at Hillsdale College.