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November 2, 2017

Initial Thoughts on the GOP Tax Bill

November 2, 2017
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House Republicans today unveiled their much-anticipated tax bill, which contains the most extensive reform of the tax code since the landmark 1986 overhaul. Although we have not fully digested the details, we can offer some initial observations from the perspective of IER’s focus on free energy markets.

What’s In a Name?

H.R. 1 is aptly titled “The Tax Cuts and Jobs Act.” This is consistent with President Trump’s campaign rhetoric, as well as the familiar theme of conservative and libertarian policymakers that prosperity occurs by unleashing American entrepreneurs and returning resources to the private sector.

Regarding the claim of “tax cuts,” the bill delivers: It contains an estimated $1.51 trillion in reduced revenue over its first decade, which is the permissible limit for political reasons. As the New York Times explains, “Lawmakers must keep the cost of the bill to $1.5 trillion if they want to pass it along party lines and avoid a filibuster by Democrats. Lawmakers have been scrambling for days to find a way to make cuts that are expected to cost trillions of dollars into a $1.5 trillion hole.”

Net Tax Cuts

The fact that the package contains enormous cuts on net is significant, because many academics and policy wonks look down their noses at revenue losses. They instead insist that Washington deserves every penny it is currently collecting, and that the only function of “tax reform” is to rearrange the burden in a way conducive to faster growth.

In that context, it is refreshing to see that Republicans are willing to take a “pay cut” and given net tax relief to Americans. And as I explained in a previous post, federal receipts are currently 0.5 percent of GDP higher than the historical average from 1950-2016, so it’s not like Uncle Sam is starving for revenue.

Bringing the Corporate Tax Back to Civilized Levels

One of the major components of the GOP bill is its reduction of the federal corporate income tax rate from 35 percent down to 20 percent. To appreciate just how absurdly high the current rate is, this Tax Foundation analysis in 2016 found that the combined federal and state corporate tax burden made the U.S. the third worst country on planet Earth, out of a sample of 188 tax jurisdictions.

The Tax Foundation report explained: “The U.S. tax rate is 16.4 percentage points higher than the worldwide average of 22.5 percent and a little more than 9 percentage points higher than the worldwide GDP-weighted average of 29.5 percent.”

By slashing the federal rate by 15 percentage points, the GOP bill is in no way “irresponsible” but instead is placing the tax treatment of corporate income more in line with the rest of the world, especially the other major economies which compete for international investment.

Although economists are currently arguing over the numbers (see this post from Greg Mankiw as well as the links at the end), there is broad agreement in the literature that taxes on capital are particularly destructive, especially in today’s financial landscape where capital is so mobile across countries. By significantly reducing the penalty on net corporate income, the GOP plan will boost the incentive to save and invest in American assets. This will increase the accumulation of physical plants, tools, and equipment, boosting labor productivity and ultimately the real wages of workers.

No Hint of a Carbon Tax

Over the years, we at IER have written extensively on the economics of a carbon tax (see here and here for example). Lately there has been a small but vocal group of academics and former political officials urging conservatives and libertarians that they should embrace a “carbon tax deal.” The idea is that the U.S. government would implement a new carbon tax, but would promise to devote all of the new trillions in revenue to dollar-for-dollar tax rebates or cuts elsewhere. The people pushing such a deal assure their listeners that it will result in a “win-win,” where conventional GDP growth is stimulated and carbon dioxide emissions are reduced.

This promise has always been dubious, as the standard literature shows that virtually all of the carbon tax revenues would need to be devoted specifically to reductions in capital taxes (such as the corporate income tax) in order to avoid hurting the economy. Politically, the prospect of making electricity and gasoline more expensive—which hurts the poor the most—in order to fund tax cuts for corporations, seems absurd.

For example, a 2013 Resources for the Future (RFF) study concluded that if the revenue from a $30 per ton carbon tax were given back to citizens as lump-sum dividend payments, then GDP for years would be more than 3 percentage points lower than it otherwise would have been. (See my discussion here.) I would add that things would be much worse if the federal government spent any of the new carbon tax revenue.

In this general context of the tax reform discussion, it is important to note that the GOP bill doesn’t even mention the word “carbon.” (Here is the section-by-section document, and here is the full bill.) For now, it seems, GOP lawmakers were not convinced by faulty arguments based on misstatements of the tax literature.

Conclusion

There are many controversial measures contained in the GOP bill. In order to minimize the hit to revenue, the desired rate reductions were matched by the elimination of many deductions and exemptions. Some of these, such as the interest on mortgages, are quite popular and are understandably upsetting particular groups.

We at IER are not taking a stand on such matters, as it is outside our purview. From our perspective of free energy markets, we can say that the GOP bill returns resources to the private sector and avoids harmful measures (such as a carbon tax) that would drive up energy prices.

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