This post is guest authored by Victor Supyan, Deputy Director of the Russian Academy of Science's Institute of US and Canada Studies.
The U.S. tax overhaul, which became law after President Trump signed the “Tax Cut and Jobs Act,” may become the most significant element of Trump’s domestic economic policy. As impactful as it will be, the overhaul will have a much smaller effect compared to the last major tax overhaul in the 1980s; and its benefits will be inequitably distributed. It’s also unclear how the combination of tax cuts and increased military and infrastructure spending promised by Trump will affect overall economic conditions in the United States and internationally.
The law, which was passed by the Senate on a party-line vote and in the house by a vote of 224 to 201, retains the current structure of seven individual income tax brackets, but it lowers the rates. The top rate falls from 39.6 percent to 37 percent, the lowest rate remains the same (10 percent), and the next lowest rate falls from 15 percent to 12 percent. The changes will be temporary, going into effect in 2018 and expiring after 2025.
The new law also doubles the standard deductions; limits the deduction on mortgage interest to the first $750,000 of the loan; and doubles the estate tax exemption to $11.2 million for singles and $22.4 million for couples. Perhaps most significantly, the law lowers the maximum corporate tax rate from 35 percent to 21 percent, the lowest since 1939.
While this law provides some short-term benefits for the poor and middle class, in general it seems most favorable for businesses and the wealthy. The business tax cuts are permanent, while the individual cuts expire in 2025; and we can expect rates to start increasing for the poor in 2021.
Arguments in favor of the law rest on the controversial economic premise that the overhaul will lead to economic growth and new tax revenue. Indeed, the Department of Treasury projects economic growth of 2.9 percent a year on average and an $1.8 trillion increase in revenue. The Treasury report assumes the implementation of Trump’s other economic policies, including infrastructure spending, deregulation, and welfare reform. In contrast, the Congressional Budget Office estimates just 1.9 percent growth.
While the tax reform is likely to boost growth some, it is unlikely to boost the economy so much that the additional revenues сan offset the tax cuts. The correlation between economic growth and tax cuts is not direct, and U.S. economic growth typically depends primarily on the growth of consumption and investment.
Proponents of the reform point to Reagan-era tax reforms as evidence of how the economy is likely to respond. But the highest tax rate during that period was 70 percent. Even before the recent reform, rates were significantly lower, limiting the size of the effect.
Still unknown is how this tax overhaul will combine with rising military expenses and future huge promised budgetary expenses for infrastructure and the reduction of budget revenues at least in the initial stage of its implementation. Even if U.S. deficits increase, other aspects of Trump’s economic policy making—the U.S. withdrawal from the Trans Pacific Partnership, U.S. negotiations to adapt NAFTA, plans to cut trade with China, etc.—are likely to have a more significant effect on international economic trends.