THE PROBLEM WITH DELAYING THE TAX CUTS

By Arthur B. Laffer, Ph.D.

“How much would you shop at a store one week before that store has its big discount sale?”
November 15, 2017

The plan released by Senate Finance Chairman, Orin Hatch, on November 9th includes a delay in cutting the corporate tax rate from 35% to 20% until January 1st, 2019, or one year later than expected.1,2 There are people who argue that the capital expensing provision (100% depreciation in one year that is scheduled to take effect on 1/1/2018 and last for 5 years) offsets the one-year delay in cutting the corporate tax rate and that even though the tax rate reduction is delayed, the accelerated depreciation feature will more than offset—in output and employment terms—the deleterious impact of any tax rate cut delay, and the economy will surge.

Here’s Speaker Paul Ryan on the issue: “Phasing in (sic) the corporate reduction still is very good for economic growth…You still get very fast economic growth and you actually are encouraging companies to spend on factories and plants and equipment and hiring people sooner with the phase in.”3

This logic is completely wrong and only goes to show how crippled economic thinking is in D.C. If the tax bill is proposed and signed into law, then the current statutory maximum corporate tax rate and current depreciation schedule are no longer relevant. You would instead ask yourself the following question: which would I rather have, A.) 100% expensing and a 35% corporate tax rate or B.) 100% expensing and a 20% corporate tax rate? If B is your answer, which it should be, then you will postpone your actions until the second year, 2019. The choice between A and B is the correct choice businesses will face if Congress passes the bill with a delay of the corporate tax rate cut.

[Paul Ryan’s] logic is completely wrong and only goes to show
how crippled economic thinking is in D.C.”

With this actual choice in mind, if you wait one year you would face a 20% corporate tax rate rather than this first year’s 35% tax rate. Who in their right mind wouldn’t delay their actions one year, thus postponing output and production until the next year? Of course, everyone will delay output and production, and the economy will suffer.

The mistake Paul Ryan is making in his quote is that he is comparing a world without any tax bill to the first year of the tax bill with the delay. This is the wrong comparison. Comparing anything with the year before the tax bill passed is a red herring. As we just wrote, if the tax bill were to pass with the delay, the choice businesses would face is Year One of the tax bill versus Year Two of the tax bill i.e.:

• Year One: 35% corporate tax rate and 100% expensing versus,
• Year Two: 20% corporate tax rate and 100% expensing.

You tell me what you would do?

Year One and Year Two above is the choice businesses will face, and, as such, if the rate is not reduced immediately, then in Year One, companies will continue sheltering income, they will continue to use tax-advantaged business forms and they will still have the same incentives to evade taxation. And there will be no incentive whatsoever for businesses to move their corporate headquarters to the U.S. In addition, businesses won’t invest any more in Year One than in Year Two because the expensing provision in each of those years is the same.

Some clever accounting type creep (like me) could really juice the economy and balance the tax cut’s supposed “revenue losses” à la the CBO by having a one-year 100% expensing provision in the first year alone and then back to the old depreciation rules the second year. Then you would see an enormous amount of investment in Year One. This is exactly what we did to help get the 1978 Steiger-Hansen bill passed.

Reagan’s 1981 tax bill made the mistake of delaying the full implementation of the tax cuts (a true phase-in) that Senator Hatch and Speaker Ryan are now considering. In 1981 when President Reagan’s tax bill passed, the President gave me a congratulatory call, yet he sensed early in the conversation that I was not as excited as he thought I should be. He was incredibly excited about getting the tax bill through—and I was too—yet I was concerned about the tax boundary effect of phasing in the tax cuts. I asked him, “How much would you shop at a store a week before that store has its big discount sale?” He saw the point immediately.

Shortly after my conversation with the President, on December 21, 1981 I was interviewed by Barron’s with regard to the tax bill. Here’s what I said in the midst of the fray:4

Q. Well, are you disappointed, so far, with Reaganomics?
A. I am not surprised about what’s happening with the current Administration. But I’m disappointed, frankly, that Stockman had enough influence to convince the President to postpone the tax cuts.

Q. Why?
A. Let me answer this way: Suppose you have to go back to school and not earn income in one of the next two years. But you get to choose which year. Which year do you go back? This year, when tax rates are high, or next year, when tax rates are low? Which is the year you choose not to earn your income? That is what we are seeing happen.

So people were deferring their income so that they could take advantage of lower tax rates in the future, and they were accelerating expenses so that they could deduct them ahead of the tax cuts. That was what I was saying then. The interview continues:

Q. What is your economic forecast, Arthur, for next year?
A. 1981, obviously, has been a bad year because they postponed the tax cuts, and 1982 doesn’t look great.

Q. You said before, Arthur, that you think the timing of Reagan’s tax cuts is off. Are you satisfied, though, that once the full impact of the program is felt…?
A. Once we are in ’83 and ’84, we are going to be in a great economy.

Q. You sound pretty definite about that.
A. Oh, yeah, there is no question of that in my mind. I couldn’t be more certain of a proposition than I am of that, given the uncertainty of my profession. Everything I look at, the fastest-growing economies in the world—from the Ivory Coast to Hong Kong to whatever—all have low tax rates. High taxes reduce the incentive to profit, and you just don’t expand really rapidly through government. Especially, not through redistribution policies.

Here’s exactly what happened with the 1981 tax bill and its phase-in. Starting in 1983 (the year the cuts were phased-in), the economy took off like a rocket. Take a look at the chart below:

The Politics

Also, remember that in the November 1982 elections, the Republicans were crushed in the Congressional races—Republicans in the House lost 26 seats to the Democrats, and the Democrats even picked up an Independent-held seat. Democrats also gained one seat in the Senate as well.

Once the tax cuts were able to work their growth miracle of 12% real GDP growth in 18 months, the politics changed. By November 1984, the Republicans won 49 out of 50 states.

Delaying the corporate tax rate cut will be bad for the economy and could be even worse for the 2018 elections, and nobody wants that to happen.4

1. Damian Paletta and Mike DeBonis, “Senate GOP plan would delay corporate tax cut, protect mortgage interest deduction,” The Washington Post, November 9, 2017. http://wapo.st/2zu0dVE?tid=ss_mail&utm_term=.d0c41a95aee6
2. The plan referred to is the Senate Finance Committee Chairman’s Mark of the Tax Cuts and Jobs Act that was initially released on November 9th.
3. Lisa Mascaro and Jim Puzzanghera, “House signals openness to delaying cut in corporate tax rates,” Los Angeles Times, November 8, 2017. http://www.latimes.com/politics/la-na-pol-gop-tax-plan-20171108-story.html
4. “No Shrinking Supply-Sider: Economist Arthur Laffer Keeps the Faith,” Barron’s, December 21, 1981.
5. In 1982, Republicans lost two Senate seats to the Democrats, but they also flipped one seat from Democrat to Republican and gained another seat upon Independent, Harry F. Byrd, Jr.’s, retirement. Their total vote count remained unchanged. Democrats, on the other hand, flipped two seats while only losing one, so they experienced a net gain of one seat.
©2017 Laffer Associates. All rights reserved. No portion of this report may be reproduced in any form without prior consent. The information has been compiled from sources we believe to be reliable, but we do not hold ourselves responsible for its correctness. Opinions are presented without guarantee.


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