A fiscal reality test for US Republicans
US President Donald Trump’s first major legislative goal — to “repeal and replace” the 2010 Affordable Care Act (Obamacare) — has already imploded due to his naivete and that of congressional Republicans about the complexities of health care reform.
Their attempt to replace an imperfect but popular law with pseudo-reform that would deprive more than 24 million Americans of basic health care was bound to fail, or sink Republican members of Congress in the 2018 mid-term elections if it had passed.
Now Trump and congressional Republicans are pursuing tax reform — starting with corporate taxes then personal income taxes — as if this will be any easier. It will not be, not least because Republicans’ initial proposals would add trillions of dollars to budget deficits and funnel over 99 percent of the benefits to the top 1 percent of the income distribution.
A plan offered by Republicans in the House of Representatives to reduce the corporate tax rate from 35 percent to 15 percent, and to make up for lost revenues with a border adjustment tax (BAT), is dead on arrival. The BAT does not have enough support even among Republicans, and it would violate World Trade Organization (WTO) rules.
The Republicans’ proposed tax cuts would create a $2 trillion revenue shortfall over the next decade. They cannot plug that hole with revenue savings from their health care reform plan, or with the $1.2 trillion that could have been expected from a BAT.
The Republicans must now choose between passing their tax cuts (and adding $2 trillion to the public debt) and pursuing much more modest reform. The first scenario is unlikely for three reasons. First, fiscally conservative congressional Republicans will object to a reckless increase in the public debt.
Second, congressional budget rules require any tax cut that is not fully financed by other revenues or spending cuts to expire within 10 years, so the Republicans’ plan would have only a limited positive impact on the economy.
Third, if tax cuts and increased military and infrastructure spending push up deficits and the public debt, interest rates will have to rise. This would hinder interest-sensitive spending, such as on housing, and lead to a surge in the dollar, which could destroy millions of jobs, hitting Trump’s key constituency — white working-class voters — the hardest.
If Republicans blow up the debt, markets’ response could crash the US economy. Due to this risk, Republicans will have to finance any tax cuts with new revenues rather than with debt. As a result, their roaring tax-reform lion will most likely be reduced to a squeaking mouse.
The only sensible way to provide tax relief to middle- and lower-income workers is to raise taxes on the rich. This is a socially progressive, populist idea that a pseudo-populist plutocrat such as Trump will never accept.
Even cutting the corporate tax rate from 35 percent to 30 percent would be difficult. Republicans would have to broaden the tax base by forcing entire sectors — such as pharmaceuticals and technology — that currently pay little in taxes to start paying more.
To get the corporate tax rate below 30 percent, Republicans would have to impose a large minimum tax on these firms’ foreign profits. This would mark a departure from the current system, in which trillions of dollars in foreign profits remain untaxed unless they are repatriated.
During the presidential campaign, Trump proposed a one-time 10 percent repatriation tax “holiday” to encourage American companies to bring their foreign profits back to the US. But this would deliver only $150-$200 billion in new revenues, less than 10 percent of the $2 trillion fiscal shortfall implied by the Republicans’ plan. In any case, revenues from a repatriation tax should be used to finance infrastructure spending or the creation of an infrastructure bank.
Some congressional Republicans who already know that the BAT is a non-starter are now proposing that the corporate income tax be replaced with a value-added tax (VAT) that is legal under WTO rules. This option is not likely to go anywhere either. Republicans themselves have always strongly opposed a VAT; there is even an anti-VAT Republican caucus in Congress.
The traditional Republican view holds that such an “efficient” tax would be too easy to increase over time, making it harder to “starve the beast” of “wasteful” government spending. Republicans point to Europe and other parts of the world where a VAT rate started low and gradually increased to double-digit levels, exceeding 20 percent in many countries.
Democrats, too, have historically opposed a VAT, because it is a highly regressive form of taxation. While it could be made less regressive by excluding or discounting food and other basic goods, that would only make it less appealing to Republicans. Given this bipartisan opposition, the VAT — like the BAT — is already dead in the water.
It will be even harder to reform personal income taxes. Initial proposals by Trump and the Republican leadership would have cost $5-$9 trillion over the next decade, and 75 percent of the benefits would have gone to the top 1 percent — political suicide. Now, after abandoning their initial plan, Republicans claim they want a revenue-neutral tax cut that includes no reductions for the top 1 percent of earners. That too looks like mission impossible.
Implementing revenue-neutral tax cuts for almost all income brackets means Republicans would have to phase out many exemptions and broaden the tax base in ways that are politically untenable. For example, if Republicans eliminated the mortgage-interest deduction for homeowners, the US housing market would crash.
Ultimately, the only sensible way to provide tax relief to middle- and lower-income workers is to raise taxes on the rich. This is a socially progressive, populist idea that a pseudo-populist plutocrat such as Trump will never accept. So it looks like Republicans will continue to delude themselves that supply-side, trickle-down tax policies work, despite the overwhelming weight of evidence to the contrary.
• Nouriel Roubini is CEO of Roubini Macro Associates and professor of economics at the Stern School of Business, NYU.