GOP Tax Reform: Incentives Matter

It appears increasingly likely the Republican Congress will pass tax reform this week.

As we analyze the plan, it’s important to remember – incentives matter.

Details of the House/Senate compromise bill came out Friday. It features a top rate of 37% and a bottom rate of 10%. The corporate rate would drop to 21%. The standard deductions would nearly double. Individuals with existing mortgages would still be able to deduct their interest, and the compromise restored the deductibility of state income taxes up to $10,000. The plan would also eliminate the Obamacare penalty for not buying insurance. There are certainly things to like.

But as Peter Schiff pointed out in his podcast, there are also significant problems with the plan. It is riddled with loopholes and incentives that will substantially raise the debt – even more than projected.

I believe it this plan passes, we’re going to have a tax code that is more gameable, where more people are doing more things to rig the system, or exploit the loopholes, not that there’s anything wrong with that … But that is why the projections that the Republicans are out there with that this is going to add just $1.5 trillion to the deficit over the next 10 years are a bunch of nonsense.”

Peter estimates the plan will add nearly twice the $1.5 trillion the deficit. That’s above and beyond what it will grow naturally through the continuing expansion of government.

Republicans claim economic growth will help “pay” for at least some of the tax cuts and the deficit will actually expand less than projected. Economic growth means more money to tax. Even at lower rates, this will increase the government’s revenue. Peter called that “nonsense.”

You cannot grow the economy simply by cutting taxes and leaving your rate of spending exactly the same. Because the damage the government does through the tax code, a lot of that has to do with spending.”

We’ve talked extensively about the impact of debt on economic growth. The US debt to GDP ratio already stands at 105%. This puts a significant drag on growth.

Of course, Peter recognizes that the tax code itself creates incentives, and tax cuts can help change those incentives in positive ways that boost growth. As he pointed out, when you penalize work and subsidize people who chose not to work, you’ll get less work. But incentives work the other way too, and that’s a major problem Peter sees with the tax plan. The way the plan structures the tax code will also create incentives, and Republicans aren’t taking that into account when they estimate the impact on the debt. As a result, the deficit is going to explode.

Peter said the Republicans are setting themselves up to take the fall for the next recession. And a recession is inevitable, even with tax cuts. The new tax plan could delay the onset of a downturn, but it won’t likely push the next recession beyond the 2020 election. Just looking at natural cycles, we are past due for a recession. When it comes, everybody is going to blame it on tax cuts.

Because they cut taxes on the rich, that is going to play right into the Democratic narrative that the tax cuts on the rich is why we have a recession.”

Peter goes on to break down various provisions in the tax code and how incentives will likely change behavior in significant ways, causing the deficit grow even bigger than projected. He noted that the new plan is extremely complicated, especially in its treatment of small businesses.

This is probably going to be the most complex tax code for businesses we’ve probably ever had. And so this is a major step in the wrong direction as far as simplicity is concerned. They have complicated the hell out of the tax code, and it was already complicated.”

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