Personal Finance

Is Trump's Tax Plan Destined For Failure?

In many ways, President Trump failed to deliver on the sweeping pledges he raised during the campaign trail. Following the inauguration, the narrative quickly shifted from draining the swamp to a bad reality show featuring broken promises and investigations into foul play. But some members of the Republican party still consider his first 100 days in office an overwhelming success. It brought forward proposals to increase defense spending, reform health care, tighten America’s borders and most recently, overhaul the tax system.

The one page tax plan unveiled in late April calls for the biggest individual and business cuts in American history. It immediately drew fire from critics about the potential impact on the federal deficit and middle class. Even the rosiest estimates suspect the proposal would yield negative economic results.

Individual Reform

President Trump’s tax proposal speaks of individual reform on three levels; provide relief to American families, simplify the tax code, and repeal the 3.8% Obamacare tax on small businesses. The plan is designed to reduce the number of tax brackets from seven to three, set at 10 percent, 25 percent and 35 percent. Lowering the upper bound limit from 39.6 percent to 35 percent offers outsized benefits to the wealthy while inadvertently expanding the federal deficit.

In other words, the government must offset lower tax revenue by borrowing more or eliminating sponsored programs. 

Arthur Laffer famously described this relationship between government revenue and taxes on a napkin nearly 40 years ago.  The parabolic shaped curve, which serves as the cornerstone for theoretical supply side economics, argues there is an optimal tax rate that maximizes revenue and doesn’t require lower government spending or greater borrowing. But critics contend the curve oversimplifies reality by reducing it to a few basic assumptions.

In a Senate hearing last week, Treasury Secretary Steve Mnuchin confirmed many of Laffer’s initial beliefs that tax cuts will pay for itself through greater economic growth. Letting the rich retain more of their earnings, in theory, encourages greater individual investment and consumption. The resulting surge in spending broadens aggregate income that indirectly benefits everyone - otherwise known as trickle-down economics.

Yet most empirical research found when wealth stays at the top, it stagnates and actually slows down economic growth. Some economists reckon Trump’s tax plan, rooted in these fundamentals, could add as much as $7 trillion in debt in the next 10 years.

The president’s tax plan also calls for doubling the standard deduction, repealing the Alternative Minimum Tax and eliminating most credits and deductions, among a few other considerations.

Business Reform

A key part of the president’s tax plan involves lowering corporate taxes from 35 percent to a friendlier 15 percent for corporations and small businesses. Politicians regularly argue that high business taxes discourage savings and investment in the United States. In the same Senate hearing last week, Steve Mnuchin claimed it hinders competitions and motivates companies to spend now or transfer large sums of money overseas. The practice of corporate inversion and transfer pricing, in particular, accounts for nearly $3 trillion stashed abroad by domestic companies.

Trump’s proposed cuts along with a one-time tax holiday aims to encourage the mass repatriation of earnings back to the United States. Supporters believe this will stimulate job growth, productivity and thereby increase economic activity.

Moreover, Trump now joins legacy Republicans who want to switch to a territory tax system, meaning companies only pay domestic taxes on profits earned in the country.

Other reforms proposed under the bill include provisions to eliminate tax breaks for special interests. 

Final Take

Although still in its infancy, President Trump’s tax plan adheres to many core principles set out by the Republican party. But not everyone believes a system of broad cuts for individuals and businesses will bear fruit. Many economists and politicians quickly labeled the plan a charity for the top 1 percent and will make it increasingly difficult to get any tax reform passed. To pass as legislation, the administration must concede to changing the plan or continue to face a tough road ahead.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Taxes Politics

Trevir Nath

Trevir Nath graduated in 2011 from Rutgers University with a Bachelors in Economics & Psychology. His Psychology and Economics degrees increased his understanding of financial markets from a human behavior perspective. Looking to further his understanding of financial markets, he went on to obtain his Masters in Economics from the New School graduating in May 2014. He currently writes about personal finance, investing and its interaction with technology. His work also appears for numerous financial websites including Investopedia.

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