In 1974, economist Arthur Laffer in making the argument for cutting taxes to top Ford Administration officials (Dick Chaney and Donald Rumsfeld) drew on a restaurant napkin a curve showing that at low rates of taxation the government could receive greater revenues, while at higher rates it received progressively less going to zero at a 100% tax rate. This then became famous as the basis of President Ronald Reagan’s tax cuts when he slashed taxes from a top marginal rate of 70% to 28%. True to the Laffer Curve, government revenues increased from $517 billion in 1980 to $909 billion in 1988, even though the population had grown by only 10%. Laffer also popularized what became known as ‘dynamic’ scoring, which took into account changes in taxpayer and business behavior in reaction to tax cuts that resulted in greater growth. Prior to that, ‘static’ scoring had been the rule, meaning that a 10% tax cut simply resulted in 10% lower government revenues. Aware of the abiding popularity of the Reagan presidency, Trump and the republicans did everything possible to advertise Laffer’s contribution as a consultant on the Trump tax cut project.

laffer curve

So what did the Trump tax cuts actually entail? The key provision is the lowering of the top rate for everybody from 35% to 21%. This brings the US tax rate, which heretofore was among the highest in the developed world, to just under the average (25%) and, alongside other advantages such as cheaper energy and Trump’s deregulation program, makes America a top investment destination.  Another important investment incentive is the one-time repatriation provision of US capital parked overseas at an average rate of 10%. This affects a huge pool of some $2.5 to $3 trillion dollars ($2500 to $3000 billion) of US companies earnings kept offshore because of the exorbitant 35% tax. Even if only half of that were to come home now, it would represent an amount almost equal to Obama’s much touted stimulus.

 

For individual taxpayers, the tax bill doubles the standard deduction and brings significant tax savings to the middle class. For instance, according to the Tax Foundation, a family with two children that makes $82,000 will save 20% in taxes, while a single parent with two children and an income of $52,000 will save 36%. For business, apart from the huge general tax break, the bill makes it possible to deduct 100% of new investment immediately, a huge bonus.

 

Despite, the mainstream media propaganda that the republican tax bill aims to help only the rich, there are a number of provisions in it that do exactly the opposite. One is capping the tax deduction for home mortgages at $1,000,000 and eliminating it for second homes, which affects mostly the wealthy. Another, and more seriously detrimental one, is the capping at $10,000 of the deduction for state and local taxes, which was unlimited until now. This affects particularly rich people in high tax states, such as California and New York, and could cost them hundreds of thousands of dollars. The governor of California, Jerry Brown, for example, is already on record claiming that the bill is not only stupid but also a republican war on his state.

 

There are, of course, numerous other provisions that space does not allow us to treat here, but this should be enough to get the flavor of the largest American tax reform since 1986. As all significant reforms, this one too is likely to have considerable political repercussions and both sides of the political spectrum are already mobilizing to make the tax cuts the focus of their campaigns in the mid-term congressional elections in 2018. The democrats, as mentioned, are preparing to base their campaign on the simple argument that Trump and the republicans have pushed the tax cuts for the single purpose of rewarding their fat cat donors. The GOP, on the other hand, will argue that the chief beneficiary of the bill will be the middle class and also that it is likely to boost economic growth as the Laffer Curve would argue. The Tax Foundation, for instance, has already claimed that each dollar in revenue lost to the government would result in an additional $1.90 gained because of higher growth in the 3% range. Already, a number of large businesses like, Bank of America, ATT, Comcast, etc have promised to give all of their employees bonuses of $1000 as a result of the tax cut.

 

Who is right would not become known until the fall of 2018, but it is worth noting that the democrat strategy is risky. After all, it was a democrat icon, John F. Kennedy, who coined the greatest advertisement ever for tax cuts – “a rising tide lifts all boats,” and the fact that this is the only tax cut bill in congressional history for which not a single democrat voted.

 

By Alex Alexiev

One thought on “Trump’s Tax Cuts and the Laffer Curve

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