The Cost of the Republicans' Tax Delusion

(Bloomberg View) -- Last June, the center-left government in Sweden proposed cutting the country's top corporate tax rate, already a below-the-international-average 22 percent, to 20 percent. The rate cut would be offset by a set of limitations on the deductibility of interest, so overall the Swedish government -- currently running a fiscal surplus of more than 1 percent of gross domestic product -- did not expect any revenue loss from the changes.

The proposal has been slowly working its way through the Swedish system since then. After a comment period that ended in September, the government began composing legislation that is due out the first half of next year and expected to take effect on July 1. The interest-deductibility changes, aimed at making "aggressive tax planning" harder and reducing corporate debt, are the centerpiece of the plan, so the reduction in the corporate rate may become bigger or smaller once the interest provisions are finalized.

Here in the U.S., lawmakers are also close to finalizing legislation that would cut the top corporate tax rate to 20 percent and limit interest deductions by corporations. Just like Sweden! Except for this part: Given how much higher the U.S. corporate tax rate was to start with (35 percent), the revenue loss from the rate cut is going to overwhelm the gains from the interest deduction limits. As a result, a fiscal deficit that's currently at 3.5 percent of GDP seems likely to pass 4 percent, even if the legislation delivers a substantial boost to economic growth.

I have written several columns lately about Republican claims that tax cuts will pay for themselves from the resulting increase in economic growth, and have been wondering why I get so worked up about them. The obvious reason is that the claims are false: No serious analysis by even the most sympathetic economist has found any of the big tax-cutting legislation enacted or proposed since 1980 to be even close to revenue-neutral.  And so while I really can't say with confidence whether the tax bill being hammered out by House and Senate conferees this week will be good for the U.S. economy or bad, I can say with confidence that when Senate Majority Leader Mitch McConnell asserts that the bill will be revenue-neutral or better, or Treasury Secretary Steven Mnuchin trots out a joke of an "analysis" to make the same claim, they are full of baloney.

But I think what may bother me even more is that this insistence on the magical properties of tax cuts seems to have prevented the U.S. from taking full advantage of the actual positive properties of tax cuts and tax reforms that other wealthy countries such as Sweden have discovered over the past few decades. Since Ronald Reagan was elected president in 1980, it has worked something like this in the U.S.: Republican true believers push for tax cuts that often have quite sensible aspects but leave gaping holes in the budget, which subsequently have to be filled by Republican realists (George H.W. Bush in 1990) or Democrats, who generally try to do so by increasing taxes on the wealthy.

The result is a tax system that relies more heavily on income taxes than is the norm among members of the Organization for Economic Cooperation and Development, the club of the world's affluent democracies, and also levies those taxes more progressively (that is, there's a bigger gap between the top rate and the middle and bottom) than most other rich countries do.

The U.S. also has the highest statutory corporate tax rate among OECD members (which of course may be about to change big time), but the actual taxes it collects from corporations are below the OECD norm. Not coincidentally, the U.S. runs one of the biggest government deficits in the OECD. Its economy has also failed to grow significantly faster than those of other OECD countries (Sweden, for example) with much bigger overall tax burdens -- a result, economist Peter Lindert has convincingly argued, of much more economically efficient tax and social-welfare systems outside the U.S.

Now it's possible that I have the causation backward. Maybe it's mainly Democratic unwillingness to consider the economic benefits of a flatter, more consumption-oriented tax system that has kept the U.S. from moving more in that direction. But given that it's the Republicans who have mostly driven the national discussion on taxes since 1980, and are certainly driving it right now, it seems fair to focus on what they're doing and what they say.

What they've been doing this fall is pushing through a tax bill with some sensible aspects (and some not-so-sensible ones!), while not just largely ignoring its negative impact on government revenue but claiming against all evidence that it won't have a negative impact. Instead of responsibly advancing their priorities, they're leaving a mess for somebody else to clean up. And it's unlikely to be cleaned up in a way that either Republicans or Swedes would approve of.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”

1. I got that from Google's translation of the government's press release  from last June. 

2. According to the Joint Committee on Taxation's estimates (a pdf of which downloads automatically if you click on this link the House bill's rate cut would cost trillion over years, while the deduction limit will bring in billion; for the Senate bill those numbers would be trillion and billion. These estimates do not factor in projected macroeconomic effects of the legislation.

3. I'm not including the Tax Reform Act of which cut some tax rates but wasn't billed as a tax cut and does in fact appear to have been close to revenue neutral.

4. Restraining spending is of course another way to fill the gaps. But since the presidency of Bill Clinton, when reductions in defense spending (both in dollar terms and as a percentage of GDP) coincided with a demographically driven decline in Social Security outlays (as a percentage of GDP) to allow for a significant decline in government outlays (again, as a percentage of GDP), this has proved hard to accomplish.

5. It's also worth mentioning that one of the current bills before Congress that would do the most to move the U.S. toward a more consumption-oriented tax system is the Progressive Consumption Tax sponsored by Democratic Senator Ben Cardin of Maryland.

To contact the author of this story: Justin Fox at justinfox@bloomberg.net.

To contact the editor responsible for this story: Katy Roberts at kroberts29@bloomberg.net.

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