Pitfalls of Trump’s “Cut Cut Cut Act"

Posted by Shyam Moondra

During the presidential campaign, then candidate
Donald J. Trump often talked about unprecedented tax cuts for the middle class and tax reform, as one of his goals for the first 100 days of his presidency. However, the bruising infighting among the Congressional Republicans on repealing and replacing Obamacare wasted a lot of time and ultimately their attempt failed in the Senate. The Congress then started the process of passing a legislation on tax cuts and tax reform. The House passed the “Tax Cuts and Jobs Act” and the Senate is only days away from passing their own version of the law which widely differs from the House version in many aspects. Of course, President Trump coined his own name for the eventual bill as “Cut Cut Cut Act” to emphasize his claim that his tax cuts would be even bigger than the record tax cuts enacted by President Ronald Reagan. The Congress, however, is unlikely to adopt Trump’s suggested name. After the failed attempt to repeal and replace Obamacare, the Congressional Republicans are under tremendous pressure to pass a tax cut legislation to show to the Trump supporters that they can govern. After the Senate passes its own tax cut bill, the House and Senate conferees will then try to sort out the differences between the two versions and have a bill ready for President Trump’s signature before the end of the year.

Currently, economy is operating at “full employment” level and GDP is growing at 3% per year with modest inflation. The tax bill passed by the House will will undoubtedly add to the inflationary expectations. Tax cuts are usually used as a fiscal policy tool at the bottom of economic cycle to stimulate economy, but this time around tax cuts are being proposed at a time when economy is operating at the peak level. If tax cuts lead to higher inflation, the Federal Reserve Board (FED) will be forced to increase interest rates at a higher rate than originally planned and if FED is not able to fine tune rate increases, they could even trigger recession. Besides, Trump has ambitious plans for infrastructure improvements and military upgrades that will add additional trillions of dollars to the budget deficit over 10 years. The timing and magnitude of the proposed tax cuts are thus very risky.

The Trump administration is relying on increased economic activity to generate enough additional tax revenues which will offset the anticipated budget deficit caused by tax cuts. However, most economists believe Trump’s claim of growth are overstated and they estimate that there would be a net increase in national debt by at least $1.5 trillion. Higher budget deficit and national debt will put additional pressure on FED to increase interest rates. Higher interest rates will slow down housing market and demand for durable goods such as automobiles, possibly triggering crash of financial markets which could lead to recession.

During the campaign, Trump emphasized tax cuts for the middle class and tax simplification, but the proposed legislation does neither. By most estimates, the bulk of the tax cuts will go to the corporations and rich people and the proposed tax plan wouldn’t really do much in terms of simplification. The tax code is riddled with special interest provisions that make the tax return more complicated for most people than is necessary.

Given the political necessity to pass something on taxes, after having failed to repeal and replace Obamacare, Republicans have no choice but to do something, anything, on taxes. Hopefully, the conferees from House and Senate would iron out the differences and make tax cuts targeted more at the middle class and scale back corporate tax cuts to reduce budget deficit. Politically, it’s hard to justify big tax cuts for the rich at a time when rich individuals have done so well since the financial crisis and income inequality among the population is at a record level. Congressional Republicans need to go back to Trump’s original twin objectives: create high-paying jobs and give a boost to wage growth for the middle class that accounts for two-third of economy.