A Middle-class Tax Cut: Weighing the Costs and Benefits

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Wharton’s Jennifer Blouin speaks with Wharton Business Daily on Sirius XM about the potential for “Tax Cuts 2.0” by the Trump administration.

In the run-up to the 2020 Presidential elections, the possibility that the Trump administration might offer a middle-class tax rate cut to 15% has set economists and other experts weighing the costs and benefits of such a move as well as its political implications.

To be sure, a tax rate cut to 15% for middle-income individuals would impose a higher burden on the federal debt, which is already weighed down by the 2017 tax cuts for corporations and individuals, according to experts at the Penn Wharton Budget Model (PWBM), a non-partisan research organization. Still, it would also inject a short-term boost and steady economic gains over the long run, they said.

One trigger for the debate on the issue was a Washington Post report last week, which said the Trump administration is looking into a possible middle-class tax rate cut to 15%. A day earlier, Larry Kudlow, the National Economic Council Director, had told CNBC that “the president has asked me to pursue something called Tax Cuts 2.0.” The proposal is in its preliminary stages, he noted. “This thing will not be completed for many months … it will be released as a strategic pro-growth document for the [2020 presidential election] campaign. We want to see middle-income taxpayers get the lowest possible rates.”

Costs and Benefits

In its analysis, the Penn Wharton Budget Model considered two scenarios: one in which the individual income tax rate is permanently lowered to 15%, and the other in which it is allowed to revert to 25% beginning in tax year 2026, as is currently envisaged.

“A middle-bracket rate cut would add between $0.8 trillion and $1.3 trillion to the federal debt over the next 10 years, depending on if the rate cut was allowed to expire beginning in 2026 (similar to the Tax Cuts and Jobs Act of 2017 individual rate cuts) or was made permanent,” said Richard Prisinzano, director of policy analysis at the PWBM. This estimate is for lowering the marginal rate for the current 22% income tax bracket to 15%, he noted.

“In the temporary case, we expect the economy to receive a short-run boost as individuals work in advance of the coming rate increase,” Prisinzano continued. “In the permanent case, we expect to see less of a short-run boost, but steadier, long-run gains for the economy as debt effects are offset by the increased incentives to work.”

The country’s GDP growth rate is estimated to rise 0.1% from 2030 through 2050 if the 15% tax were to be temporary; GDP growth would be higher at 0.4% during those periods if the tax cuts were made permanent, the PWBM study said.

“It’s easy to say we’d just like to cut rates for the middle class, but there have been virtually no details about how that might work,” said Wharton accounting professor Jennifer Blouin in an interview on the Wharton Business Daily radio show on SiriusXM. (Listen to the podcast at the top of this page.) “So, [it] clearly sounds like an election play.” Talk of “tax cuts 2.0” is gaining ground even as the earlier round of tax cuts delivered much lower GDP growth rates than were projected, a decline in business investment and an increase in bankruptcies in the coal and farm sectors, according to an opinion piece in the Washington Post.

Who and How?

Blouin highlighted several difficulties in rolling out a tax cut for the middle class. For starters, it would be “tricky” to both define “middle class” and design a tax cut in the present regime of graduated tax rates, with multiple slabs, she noted.

The 2017 Tax Cuts and Jobs Act lowered individual income taxes across six of the seven income slabs, from levels between 15% and 39.6% to 12% and 37%, effective in 2018. It also doubled the standard deduction and provided medical and estate tax benefits but eliminated many exemptions and deductions, as listed by a report in The Balance. The 2017 act also lowered corporate taxes, with the top rate falling from 35% to 21%, along with other business tax changes.

“A middle-bracket rate cut would add between $0.8 trillion and $1.3 trillion to the federal debt over the next ten years.” –Richard Prisinzano

“If we want to cut a rate, does that mean we’re going to cut one of the rates in the middle?” Blouin asked. “If that’s the case, then an awful lot of that benefit will inure to essentially the high-income bracket folks as well, because they qualify for that lower rate. Or, is it intended that this rate just triggers into some group of individuals that have a certain level of income? But then that adds a whole additional layer of complexity that would be crazy to administer.”

Blouin noted that while benefits to corporations totaled $341 billion in the $1.5 trillion bill, individuals gained the most – about 75% – including self-employed individuals. The Trump administration has sought to make the individual tax benefits permanent beyond 2025, when they are set to expire.

Against that backdrop, “I’m not sure how we would tease out exactly who gets what if we add this [middle-class] rate cut on top of everything that’s going on from the last bill,” said Blouin. According to her, it would be difficult to justify making the individual tax breaks contained in the 2017 tax act permanent, “given that we haven’t seen the growth or the uptick in the economy that we need to help pay for the last tax bill.”

Call for Tax Reform

Blouin said that after the 2017 tax cuts, it has been difficult to determine the link between business activity and economic growth because of the adverse impact of trade wars with China and other countries. “You significantly altered the international regime in a way that’s creating a lot of confusion,” she said. “A lot of companies are waiting until the next election to see if they even get to keep their rate cut.”

“A lot of companies are waiting until the next election to see if they even get to keep their rate cut.” –Jennifer Blouin

These concerns underscore the need to explore ways to refine the tax structure in general, according to Blouin. “The goal is to ultimately goose growth in the U.S. in terms of employment and productivity, and [other] attributes along that line,” she said. She also cautioned against taxing productive capital, explaining that such moves are not good for economic growth.

While some presidential candidates have proposed new ways of thinking about how organizations should be taxed, they need to “do a better job of informing the public and the voters” about who benefits from these changes, she added.

Some education is needed on how the benefits of tax cuts are distributed, she said. “I would hope that folks would stand back and say, ‘Listen, can we educate not just the public, but also Congress, about who bears the burden of the tax?’” Here, she called for “neutral facts” or “facts without political bias” to inform public discourse on these issues.

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