This note is about the effect of the new tax law on the middle class. While much has been written on this subject, the focus has generally been too narrow to give the full picture. It is important to get this right.
This note deals with three topics:
- Who really wins and loses with the tax cuts.
- How the tax cuts affect the economy.
- What about the corresponding budget cuts?
Most discussions of the tax law stop with item 1. That is to put it mildly deceptive—as if the tax cuts were free money we just printed, and we’re only deciding how to divide up the proceeds. That’s understandable from Republicans, but others shouldn’t let them get away with it. Items 2 and 3 talk about consequences. Item 2 affects everyone; item 3 needs to be analyzed to see how it hits the middle class. However even the discussions of item 1 have understated the situation, so we start there.
- Who really wins and loses with the tax cuts.
Most discussions of this topic focus on the new rules for personal tax filing. This is of course complicated because winners and losers are different in different states and with different levels of income or expenses. For our purposes we assume that job has been done. The NY Times has a handy calculator. In the first year about 75% of payers get a tax cut, 25% pay more. The median result over the entire population is a tax cut of $380. By 2027 some cuts expire and virtually everyone pays more.
The first caveat is that this forgets that the federal tax isn’t the only tax paid. The new tax law has two conflicting effects on state taxes. On one hand the limited deductability of state taxes has made taxation more expensive to the payers in high-tax states. On the other hand the corresponding federal budget cuts will throw additional social welfare expenses back on the states. States will have to choose between increased misery and tax increases. Given the modest size of middle-class tax cuts, it takes little at the state level to negate them.
However the bigger part of the story is that we have left out two major pieces of the tax law. One is the frequently-discussed new 25% rate on pass-through income. We know it’s free money if your personal tax rate is higher, but it’s hard to quantify since we don’t know exactly who will use it. With the armies of accountants hard at work on it, let’s just say that since the 32% tax rate starts at $315,000, you have to be at least borderline rich to cash in.
The remaining piece of the tax law is the huge corporate rate cut—the biggest part of the package. The issue here is that the effects of corporate cuts have not been put in proper context. On one hand we have Trump and Mnuchin talking about how the cuts will be worth $4000 for all workers (a number that very few regard as true). But on the other hand the huge rise in the stock market (even after the recent retreat) is somehow taken out of scope—a benefit to everyone from the Trump presidency. In fact the stock market rise is the primary rich-taxpayer payoff from the tax plan—and it has been a great deal!
There are several points to be made:
– The corporate tax cuts are a direct tax benefit to rich tax payers.
This is just arithmetic: cutting corporate taxes increases profits and hence the financial value of what the investors own. From the beginning, the expectation of tax cuts has been the primary driver of the stock market boom. Since stock ownership increases dramatically with income (see the chart below), this means that the value of the corporate tax cut is hugely tilted toward the rich.
It’s worth emphasizing just how skewed this is. The chart shows 84% of stock is owned by the top 10% of taxpayers, but the top 1% own 40%.
– What about the bonuses to workers?
We’ve had a few public relationship announcements of benefits, but there’s no reason to expect this will represent a significant part of the tax cut effects. At a qualitative level, one has to believe the stock market—which clearly thinks there will be no substantial loss of profits to wages. In fact the recent stock decline was caused by the fear of inflation based on statistics showing a 2.9% annual increase in wages. Shows how likely the business community is to put tax cut benefits into wages! Even Mnuchin’s improbable $4000 was actually a long-term benefit (i.e. years out) based on estimates of productivity increases from projected new investments.
The link between the corporate tax cuts and investors benefits is immediate and direct. The link to worker benefits is indirect and historically shaky. The following unedited statement from a Cisco financial report is an excellent introduction to the real world:
“Because of the law’s corporate tax cut, Cisco plans to repatriate in the current quarter $67 billion parked in foreign banks. The company plans to spend the money on dividends paid to shareholders, stock buybacks and acquisitions.” (With experience, we can now be even more explicit—thus far in 2018 corporations have spent $171B of tax savings on stock buybacks and $6B on employee bonuses.)
– What about jobs?
In 2004 the Bush administration granted a tax holiday for businesses to return overseas earnings. Many businesses took advantage of the gift, but none of the promised increase in jobs materialized. That was actually not surprising, because job increases go with new ventures—and the extra cash doesn’t create those opportunities.
The picture is even more tilted that way today. The cost of capital has been so low, that it has been simply no impediment to investment. Any reasonable project is fundable. The corporate tax decrease, large as it is, doesn’t change that picture. And even a little bit of inflation counteracts it entirely.
– Will the tax cuts bring international operations of businesses home to the US?
The corporate tax cuts mean that businesses will pay less tax than they used to for their operations in the US, so in that sense there is less disincentive for operations here. However, the new tax rules mean that going forward businesses will pay NO tax on their operations overseas. End of subject!
– What about foreign companies putting operations here?
That amounts to subsidizing their operations by our policies here. Good for them, not so good for us.
– What about the corporate announcements of expansions in the US?
Corporate announcements are a little suspect, because it’s tempting to jump on the bandwagon for public relations reasons. One obvious example is Apple who announced a $350 billion investment in America over a period of 5 years. As it turns out Apple’s current annual domestic investment amounts to $275 billion over five years, so we’re down to $75 billion new. In addition, with the new tax law Apple returned $252 billion from overseas to take advantage of the tax holiday rate of 15%. That means 38 billion of the $350 went to taxes for a total new investment over 5 years of $37 billion. Not such a big change and probably still somewhat inflated.
It’s also worth thinking a bit about that $252 billion in overseas saving. That huge number for overseas assets is a tribute not just to Apple’s overseas business but also to modern accounting practices by which companies attribute profits to subsidiaries in convenient places. The new tax law—with no tax on overseas operations—creates an even greater incentive for such creative profit shifting. The new approach was sold as putting US taxes on the same footing as for the Europeans, who also don’t tax foreign profits. However the Europeans have complex rules to avoid profit shifting, and those rules go far beyond anything in our new law. So this is another really great deal for the investors!
Conclusion: The direct financial effects of the new tax law are vastly to the benefit of the rich, and the greatest beneficiaries are the very richest. In particular, it is incorrect to think of the huge corporate tax cuts as a general stimulus that rains benefits on everyone. It is a tax present to investors who have shown via the markets that they expect to make out like bandits. (Since this tax plan was pushed through by ultra-rich investors for their own benefit, the analogy is exact.)
- How the tax cuts affect the economy.
From the beginning this has been the most obvious concern with the Trump administration’s policies. As we’ve noted before, the new tax plan is doing a massive, deficit-funded stimulation of an economy at essentially full employment while eliminating all oversight of speculation and other bad behavior. That is a demonstrated recipe for disaster. We’re only ten years from the crash of 2008, and we seem to have forgotten that such things really can happen.
The Trump administration is so intent on delivering its gifts to corporations and the ultra-rich that it cannot begin to think about matters of timing. There is a confluence of evils. For the Trump people, ignorance of economics and history makes them unaware they are playing with fire. For the Koch-financed Republican Congress, enthusiasm for the unregulated greed of the nineteenth century makes them blind to the crashes and panics of capitalism in the wild. From one economist recently: “I think we should be very worried. As a macroeconomic matter, I’m not aware of another example of this—of a country that’s basically at full employment embarking on massive fiscal stimulus.” And he hasn’t even gotten to the demise of financial oversight!
It is worth thinking a little about other ways the administration’s stated goals could have been achieved. The average effective corporate rate for the US is not the statutory 35% but more like 24%, which is not so far from the developed-country average estimated at 21%. Real tax reform would bring the effective and nominal rates in closer line with each other–with the advantage of removing artificial lobbyist-created inequities in the tax plan. That, with adjustments to assure parity with other countries, would not have broken the bank.
Such a plan would have been in line with the revenue-neutral tax reform achieved with bipartisan support under Reagan in 1986. It would have allowed the country to address its real and pressing problems (see the next section), it would have minimized inflation and growth of the deficit, and it would have avoided the catastrophic risk just described.
Conclusion: We need to stop some part of this train wreck waiting to happen.
The tax plan actually shows Trump’s dedication to fighting climate change. Thus far the only year when carbon dioxide production actually fell was when the world economy collapsed in 2008. Trump is out to beat that one!
- What about the corresponding budget cuts?
One way to think about this subject actually comes from Trump’s State of the Union speech. Towards the end of the economic discussion Trump turned dreamy (“we’re all dreamers!”), stared into the air, and talked about how the new America is the place for young people to start off building their lives.
Like much of Trump’s rhetoric this was a call for people to think back to the good old days of the (idealized) 1950’s and 60’s, the days that Trump wants us to think he is recreating. We should talk about those good old days, the reality for young people starting off in Trump’s America, and what really ought to be done about it.
First about those good old days:
– Employment: This was an era of strong unions, with corresponding good wages and working conditions. Companies offered lifetime employment. Employment was a clear path to a middle-class lifestyle.
– Medical care: Affordable without worrying too much about it. Coverage built around employment.
– Education: The GI bill had sent people of all kinds to college for the first time. The state university system in full expansion made college affordable. Everyone’s kids get a newly-won chance to do anything.
– Retirement: Companies offer full pensions, based on years of lifetime employment.
– Infrastructure: New and enhanced through public spending. The interstate highway system is a key new achievement.
– Environment: Getting better as we begin to pay attention to it via the newly-formed ecology movement with bipartisan support.
– International: The world had learned that war was a bad idea. International institutions formed to diffuse it and to prevent another depression.
Overall this was a time of confidence—as long as you weren’t black! People could feel sure that they knew how to create a life trajectory for personal success and for their children.
Let’s revisit those topics now in light of Republican policies in general and the tax cuts in particular.
– Employment: Unions have lost power in most industries. Globalization and (even more) automation have changed and are continually changing the nature and number of good jobs. Lifetime employment is rare. The “Gig economy” has few benefits. Compensation has a very large range with the minimum wage unchanged for 15 years. There is a current threat of a new round of job losses from artificial intelligence. Overall—employment is uncertain and not a guarantee of a middle-class lifestyle. And if you lose your job you lose everything.
Republican policy>> The administration is actively hostile to unions and to regulation of working conditions. For other issues Trump has pegged everything to his stimulus of the economy and his renegotiating of the trade agreements. That resolves few of the problems just mentioned. In the State of the Union speech Trump talked about retraining, but thus far has announced only cuts to existing training programs. There’s no room in the budget for government-funded jobs programs, including especially infrastructure (discussed later). Hostility toward government-funded research is a bad sign for the future.
– Medical care: Medical care has become a huge part of national spending and a major worry to most people. Prior to Obamacare there were 500,000 medical bankruptcies per year in the US, most for people who thought they had insurance. Obamacare was a first step to move beyond an expensive, dishonest, inequitable, and incomplete non-system. Obamacare was of course financed with a surtax on higher incomes that has been a primary Republican target. Obamacare isn’t dead, but Trump has tried to kill it through a number of measures to raise its cost and create uncertainty about its operation.
>> Republicans have tried for years to get out of the healthcare business. Trump’s healthcare promises made them create proposals, but none were serious. The first two killed the surtax directly, and the third pushed responsibilities to the states with diminishing federal funding. The recent Medicaid waiver action allows states to cut medical services, since that improves the recipients’ lives by making them more self-reliant!
The tax bill removes the Obamacare healthcare mandate, which undermines the insurance pools and increases costs for those remaining. Further Paul Ryan has announced that the tax bill deficit means going after Medicare. Trump recently acknowledged the opioid crisis, but provided no funding to do anything about it.
– Education: State financing of education has never recovered from the 2008 recession. One consequence is the college student debt crisis, and state funding of K-12 education is also down.
>> In a reasonable world the federal government would act to support the financially-strapped, state-based education system. Instead, with the rising state social service burden, the tax plan puts the states under even more stress.
The Republican party has turned alarmingly anti-education—for the public system. Trump’s State of the Union speech mentioned only “vocational education” as an issue, and there have been calls not to waste taxpayer money on anything else. There’s nothing wrong with vocational education, but it’s not the whole picture, and there’s no indication that public officials are choosing exclusively that for their own children. Further, Trump’s budget proposal takes money away from public schools to kick-start the DeVos voucher system—with educational quality sold to the highest bidder.
The tax bill has no money to fix the student debt crisis, but it goes out of its way to provide a new tax deduction for private school tuition payments! We are in danger of losing the legacy of the GI bill to a new notion of “good enough” for the public system. This is bad both for individuals and for the country overall. Other countries have now long recognized what we used to know—broad-based educational success drives prosperity. Our once-best upward mobility made us what we are.
– Retirement: Companies don’t do it anymore. Most soon-to-be retirees have little savings.
>> The tax bill deficit means Social Security is under siege from House Republicans.
It should be noted that Social Security is not actually bankrupt—it has enough current income to pay ¾ of benefits from income. Its big problem is that with growing inequality, less and less of income is taxed to support it. No one is fixing that problem.
– Infrastructure: Problems have been well-documented and were acknowledged by both candidates in the election.
>> From the State of the Union speech, Trump expects the states and the private sector to foot most of the bill for infrastructure. States have no money, as noted earlier. Private sector financing is historically limited and only goes where there’s money. Infrastructure work has the potential to help with both employment and competitiveness, but there is nothing left in the budget to make it happen.
– Environment: Technological change and lobbyist spending means that it is always tough to be one step ahead of industry.
>> The administration views all environmental regulation as the enemy. The withdrawal from the Paris Climate Accords is part of that picture. The EPA is a prime target of budget cuts.
– International: This is a period of growing interdependence but with increasing sources of instability. The US used to lead in establishing order, and it profited from that role. We have now abandoned that and are increasingly threatening unilateral military action.
>> The tax plan budget has extreme cuts to the State Department together with a large increase in spending for traditional military hardware. The change of emphasis is unnerving, and the military part eats up a large part of the budget after tax cuts. One also can’t discount the real risk of conflict.
Conclusion: The result of all this is how insecure life has become for many American families. Employment has become riskier, government support has not evolved to help, and fundamental services such as education, healthcare, and infrastructure can no longer be counted on. The new tax law makes all of that worse, because of specific policies (education, healthcare) and because there’s just no money left (infrastructure). The government has been put out of the running to address the problems we actually have.
In final conclusion, we can sum it all up by saying this is a tax plan for a two-tiered American society, where the very rich are secure in their status and their ability to pass it on to their children—and the rest of us are performing without a net. Middle class opportunities are there but shrinking, and it’s easy to fall out. It’s hard not to think about the symbolism in the State of the Union address pageantry, where a crowd of overwhelmingly rich and overwhelmingly white people cheered wildly for the few others who were brought in to do the job of making them richer.