How Donald Trump’s fiscal policy might not be so contradictory

Image: LeStudio1
Image: LeStudio1

During his unconventional and highly controversial campaign to be President, Donald Trump made all kinds of promises regarding economic policy, many of which seemed to be contradictory. He promised to reduce the national debt, while at the same time slashing taxes to stimulate growth – some analysts estimated this would add $9.5 trillion to US government debt over a decade – and rebuild America’s crumbling infrastructure with $1 trillion of new investment. Right. I was sceptical too, but there may be a way around this juxtaposition.

Let’s start with his infrastructure plan. Much of the rich world needs new toll roads, railways and airports and America is no exception. In the short-term infrastructure spending will pep up demand and create jobs; in the long-term better transport links will increase the productive capacity of the economy. Mr Trump made his fortune in the private sector and that seems to be where he sees the solution to America’s infrastructure problems. He’s suggested that his infrastructure plan could be almost entirely privately financed, which circumvents the issue of having to increase government spending. It also mitigates the risk of white-elephant projects (investments whose cost outweighs their economic value) because private sector partners would maintain a watchful eye on the economic viability of any proposals. And in today’s world of low interest rates there are plenty of willing investors: pension and insurance funds are desperate to invest in long-lasting assets that will generate a steady income to cover the cost of their obligations.

Now let’s take a look at Mr Trump’s tax policies. Broadly speaking, his tax plan has two prongs: he intends to cut corporation tax from 35% to 15%, and he wants to reduce income taxes with high earners being the prime beneficiaries. Cutting corporation tax is generally a good idea. For a start, the US corporation tax rate is the highest in the OECD – higher even than France! – which provides a huge incentive for multinationals to reduce their tax bill via “creative accounting” techniques. A high corporation tax is detrimental to the economy (see article) because it leaves companies with less cash to invest in new equipment and machinery, thus stifling the growth of worker productivity – the main driver of wage increases.

the author of The Art of the Deal” will most likely seek to negotiate a one-time tax amnesty deal where multinationals can repatriate their earnings

Furthermore, the US is one of the few countries in the world that has a global tax system – that means companies must pay taxes on what they make globally, rather than just within America. While this might have made sense in the past when US companies had little choice in paying those taxes, today’s more open world allows companies to shift profits towards and set up their global headquarters in countries with more favourable tax regimes.

As a result of these two factors, companies with international operations prefer to keep their earnings offshore, away from the prying hands of the American Inland Revenue Service. All told, it’s estimated that American Fortune 500 companies have an eye-watering $2.4 trillion in profits stashed overseas which has allowed them to avoid $700 billion in taxes. Mr Trump’s plan to reduce corporation tax should remove the incentive to continue hoarding revenues abroad. Furthermore, the author of The Art of the Deal” will most likely seek to negotiate a one-time tax amnesty deal where multinationals can repatriate their earnings while paying a slightly lower rate of corporate tax on them. He’s floated the idea of a 10% rate, but I think 20% would be better – it’s still an attractive proposition for companies who are avoiding a rate of 35%. While some may complain that the deal would allow multinationals to continue ducking their full tax obligations, the federal government stands to gain hundreds of billions of dollars from it. Moreover, if he’s as smart as he claims to be, Mr Trump may decide to attach conditions that insist companies invest a certain portion of those repatriated profits in the US economy.

However, Mr Trump’s tax plan is far from infallible and there are a couple of issues. First, cutting corporation tax to 15% is simply unnecessary – it won’t require a twenty-point reduction in the corporation tax rate to increase American competitiveness and remove the incentives for tax avoidance. Second, it would be hugely expensive. The Committee for a Responsible Federal Budget, a fiscally conservative think-tank, However, at this point one must remember that the President’s powers over fiscal policy are checked by the US Congress – something Barack Obama learnt to his dismay – and that the fiscally conservative Republicans control both the House and the Senate. With that in mind, it seems that the tax-slashing, yet budget-balancing, Republicans would moderate Mr Trump’s plan to a more affordable reduction of corporation tax to around 20% to 25%.

Mr Trump’s plans do have some merit and, if moderated by a fiscally conservative Republican legislature, may even prove more feasible than first thought

Let’s now return to the second facet of Donald Trump’s tax plan: income tax. Here is where the President-elect’s policies start to make less economic sense. Most of the windfall from his tax rates would go to the rich, who have a lower propensity to consume than poorer folk. Yet this aside, he does propose to increase the standard deduction – America’s equivalent of the personal allowance, or the amount one can earn before paying tax – from $6,300 to $25,000. This is both progressive, because poorer households will benefit the most, and economically sound since cutting taxes at the bottom of the income spectrum will provide the most stimulus for demand. Essentially, half of Mr Trump’s income tax proposals do make some sense so if he were to moderate his expensive and regressive proposals to cut taxes for high earners, while at the same time keeping his plan to increase the standard deduction, it would be more fair, economically efficient, and – most importantly – affordable.

Returning to our original juxtaposition, we can see that Mr Trump’s plans do have some merit and, if moderated by a fiscally conservative Republican legislature, may even prove more feasible than first thought. By partnering with the private sector, Mr Trump may be able to upgrade America’s crumbling infrastructure which will lift long-term productivity levels and provide pension funds that are struggling in a world of low interest rates with somewhere to invest. His tax cuts will fuel growth and investment, disincentivise avoidance and boost consumer demand via increasing disposable incomes, particularly for low-income households. Analysis by the Tax Foundation, a non-partisan think-tank, estimates that the Republican tax plan – upon which Mr Trump’s is largely based – could lift long-term GDP by 9.1%. Combining this with the effects of upgrading infrastructure may produce enough economic growth to reduce America’s debt-to-GDP ratio over the long-term. In other words, a Republican-moderated Trump plan for economic policy may indeed enable the Donald to achieve his stated aims of cutting taxes, upgrading infrastructure and paying down public debt. If this is combined with a moderation of his economically masochistic trade policy proposals, then a Trump presidency may not – at least from an economic stand point – be a complete disaster. It’s a lot to hope for and presently seems unlikely, but then again, so did the idea of Mr Trump entering the White House.

Leave a Reply

Your email address will not be published.