An important project of President Donald Trump’s administration is a long overdue tax reform, the Tax Cuts and Jobs Act (TCJA), which has been approved by the House of Representatives and now, with modifications, comes up for a decisive vote in the Senate this week.
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This initiative has been harshly criticized by many at home and abroad – the latter often as part of a wider campaign of bashing the United States. Tax legislation, by its very nature, is always easy to criticize, as some groups will feel discriminated against and others that they are not privileged enough. But in this case, the criticism does not appear to be fact-based, but rather subjective, mainly emotional and ideological.
The first argument against the tax bill is that it supposedly cuts taxes on the rich and increases them on the poor. If one looks at the proposed brackets, it is hard to find figures supporting this conclusion.
It is true that corporate income tax rates are slashed from some 35 percent to 21 percent. This will greatly help American business to develop and support its equity position. The counterargument is that businesses will use tax relief to pay dividends to their owners rather than to invest.
This is a vast oversimplification. The fact is, most U.S. companies are small and medium-sized companies, family firms, which by their nature tend to save and invest. Deregulation – and the U.S. is successfully deregulating now – will enhance business confidence and the willingness to invest.
Vastly exaggerated estate taxes were always a threat to medium-sized family businesses
In the case of larger businesses and publicly traded companies, which may indeed use some of the tax savings to pay dividends, the retired population and working people who are saving for retirement will benefit even more than the so-called rich. Especially in times of low interest rates, the main source of dependable income for the retired and steady capital growth for savers is company dividends.
A second argument is that lower tax rates will swell the federal deficit. This does not take into account, however, some long-term favorable effects resulting from the tax reform and deregulation.
The vastly exaggerated estate taxes (40 percent) were always a threat to medium-sized family businesses. While the current tax reform does not fully address this problem, at least the threshold level for incurring the estate tax has been raised so as to spare small businesses from destruction.
The tax reform abolished the possibility of deducting interest payments on debt as an expense. This makes sense, not only as a way of increasing tax revenue, but mainly as an incentive to build equity. One perverted result of combining tax-deductible interest payments and low interest rates was to encourage companies to borrow in order to buy back their own shares. This is an essential element of the present bubble in equity prices.
Existing tax laws made it unattractive for U.S. multinationals to repatriate profits. The reform bill proposes an attractive rate for repatriation. This will result in an immediate improvement in tax collections and provide a steady stream of future revenue.
Instead of criticizing the U.S., Europe should be thinking about how to downsize its own taxation jungles
Certain elements of the tax bill have been dubbed as protectionist by international opinion – but not very convincingly. A letter was sent to the U.S. Treasury from European ministers of finance (Germany, France, Italy and Spain, along with the United Kingdom’s Chancellor of the Exchequer) warning that some of the TCJA’s provisions were out of line with international norms.
Instead of immediately criticizing the U.S., European governments should be thinking about how to deregulate and downsize their own taxation jungles to make themselves more competitive. The most important issue for Europe, as in the U.S., should be to streamline government and simplify the tax and regulatory systems, making them more efficient.
The TCJA is a compromise, as most tax laws are. What it shows is that the U.S. has again taken the lead in measures to increase prosperity. The benefits of this change will be felt not only at home.