Tax Cuts: A Supply-Side Experiment
Presidential candidate Mitt Romney infamously pointed out that about half the people in the country do not have to pay income taxes. Yet, it is possible that the newly enacted "Tax Cuts and Jobs Act", as President Trump called it, will be most beneficial to the folks who pay no income tax under current law. Let me try to explain why.
President Trump and the Republicans in Congress have just launched an experiment in public finance (i.e. tax policy). The newly enacted tax law features a large reduction in corporate tax rates from 35 percent of profits, under current law, to 21 percent of profits, under the new law. The expected, and earnestly hoped-for, outcome is that lower tax rates will spur such an increase to economic growth that the country will grow out of its debt and deficit burden. While it may be an exaggeration to say the future of the country depends on a successful outcome, it is probably true that the future of President Trump and the Republicans depends on a successful outcome.
I am strongly rooting for President Trump to be correct in his policy choice to significantly lower corporate tax rates. He has good reason to be optimistic. But first, let's consider the usual economic policy and how the new tax cut law breaks from the usual policy.
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Economic policy usually follows the path espoused by mainstream Keynesian economists (i.e., those strongly influenced by the 20th century British economist John Maynard Keynes). A Keynesian view of the economy is dominated by a focus on consumer spending and "aggregate demand" (in econ-jargon). The usual economic policy is for the government to stimulate aggregate demand by borrowing money and then spending it (not always wisely) to ripple through the economy via a theoretical "multiplier".
After nearly a century of artificially boosting aggregate demand (mainly consumer spending) by following Keynesian economic policy, the US economy (and virtually every other developed country's economy) is now blanketed under a thick and burdensome layer of debt; over $20 trillion dollars at just the national level. Meanwhile, economic growth, the only path to increased economic well-being, has slowed down to a crawl over the past decade. Clearly, it is time to try a new approach to economic policy.
The Republicans in Congress and President Trump are trying a different approach, different even than the tax-cut approach of President Reagan, known as Reaganomics. President Reagan cut tax rates significantly, but he focused on cutting individual tax rates. He touted increased incentives for individuals to work, save and invest. It was known as a supply-side policy, to distinguish it from policy which promoted aggregate demand via government spending. But in fact, the Reagan tax cuts were based on the same Keynesian doctrine of stimulating aggregate demand. The only difference, and it was an important difference which helped make Reaganomics successful, was that the increase in aggregate demand (consumer spending) came from taxpayers having more money to spend instead of government doing the spending. Unfortunately, Reaganomics also spurred rising deficits and debt, just like conventional Keynesian policy would do.
This time around, President Trump is doing something different. He is reducing the government's tax take of corporate profits from 35 percent to 21 percent. He would have liked to reduce it even lower to 15 percent (The new tax law also cuts individual tax rates, but the major tax policy change is in corporate tax rates.). This truly is supply-side, production-oriented policy, not Keynesian, consumption-oriented policy. Businesses all across America will be able to use more of their top-line revenue to hire more workers, raise wages to keep current workers from leaving for higher wages elsewhere, lower prices to attract new customers and keep their current customers from the competition, and invest in new ideas or new ways to operate. Even with all this reinvestment into the business, a lower tax rate means that the business can still have the same or even better after-tax profits than under the current 35 percent tax rate. This should have a big impact on business activity and economic growth.
What President Trump understands well from his years in business (and many in Washington do not) is that America thrives when businesses prosper. The Hollywood/Bernie Sanders view is that businesses are greedy, evil, powerful institutions that must be tightly regulated or they will gladly wreak havoc on the American public. In fact, businesses struggle every day to be more effective than their competitors at finding new and better ways to serve their customers. If they slip up, they are in danger of losing market share, or worse. Think Blackberry, Sears or Kodak; all these businesses were once dominant in their industry.
Companies are voluntary organizations; owners who voluntarily provide capital to the business (for a competitive return), workers who voluntarily provide their time and effort to the business (for a competitive wage), suppliers who voluntarily supply materials and equipment to the business (for an agreed upon price) and customers who voluntarily buy the goods or services offered by the business (for an acceptable price). A profitable outcome, signifying satisfied owners, workers, suppliers and customers, is far from guaranteed.
When companies are profitable they consider how to expand and grow. Communities flourish around profitable companies. When companies are not profitable, they consider how to reduce costs; especially wages, their highest cost. Communities languish around failing companies. Lower taxes enable more companies to prosper, which leads to more growth and innovation. Companies will try to hire more workers, which will cause wages to rise as companies compete for good workers. Competition will regulate businesses more effectively than bureaucrats and drive prices to the lowest level companies are willing to go and still be profitable.
This is how the corporate tax cut will be a significant benefit to the folks who pay no taxes under the current law. They will likely be offered higher wages at their jobs, have more opportunities to find better paying jobs, and pay lower prices for goods and services. If the new tax law is successful in letting prosperity spread across the land, more Americans will end up paying income taxes under the new law and be proud to do so.
President Trump deserves recognition for his vision and boldness to fix the corporate tax rates. I am optimistic that he will win big with this experiment. There are still problems left in the economy; a large and growing national debt, insolvent entitlement programs and angry political divisiveness. But all these problems will be easier to deal with when business is thriving in America.
