Do tax cuts actually work?

President Trump's tax reform plan will benefit most U.S. households and make filing taxes simpler but it will provide the biggest windfall to the wealthy, experts say. (April 26, 2017)

President Trump announced Wednesday plans to carry out a tax reform calling for big corporate rate cuts, a simpler tax code and big increases in standard deductions.

Trump wants to reduce the tax rate for all businesses, including mom-and-pop shops to 15 percent, which Treasury Secretary Steve Mnuchin called the "biggest tax cut" in U.S. history.

The current corporate tax rate is 35 percent.

The tax reform is only a rough draft and is brief, but does note a plan to "double" the standard tax deductions as well as reducing the number of tax brackets for individual filers from seven to three, with levels of 10 percent, 25 percent and 35 percent.  

The four Republican leaders who met at the White House Tuesday night, Paul Ryan, along with Ways and Means Chairman Kevin Brady, Senate Minority Leader Mitch McConnell and Finance Chairman Orrin Hatch, released a joint statement addressing the tax reform plan.

“Lower rates for individuals and families will allow them to keep more of their hard-earned money and empower them to invest more in their future,” they said. “Getting tax rates down for American companies, big and small, will create new jobs and make the United States a more inviting place to do business.”

The idea behind tax cuts is simple: cutting taxes gives people more money to spend, boosting economic growth.

But do tax cuts really spark economic growth?

Unfortunately, this very simple concept is usually oversimplified.

The question doesn't have a yes or no answer because it depends on a variety of details.

Cause and Effect

Tax breaks are not an isolated factor relating to economic growth.

There are times in U.S. history where the simple logic behind tax cuts panned out positively. For example, Ronald Reagan's tax breaks in the 1980s spurred an economy growth spurt.

But there is no evidence showing the results of tax breaks are consistent, in fact, recent American history shows tax breaks don't always fit the economic growth agenda.

George W. Bush 2001 and 2003 tax breaks didn't result in an economy boost but Bill Clinton's 1993 tax increases created a bigger boom than seen during the Reagan era.

William G. Gale, an economist at Brookings Institution and co-director at the Tax Policy Center counters the general idea that tax breaks boost the economy.

"Both changes in the level of revenues and changes in the structure of the tax system can influence economic
activity, but not all tax changes have equivalent, or even positive, effects on long-term growth."
 
So if tax cuts are not the sole cause-and-effect behind economy boost, what are some other factors that may affect a tax break theory?
 
Government spending
 
The purpose of taxes is to fund the government. If there are less taxes coming in, there also has to be a plan on how to balance the gap.
 
Gale argues, a policy focused on tax cuts without taking spending into account will usually raise the federal budget deficit.
 
"The increase in the deficit will reduce national saving — and with it, the capital stock owned by Americans and future national income — and raise interest rates, which will negatively affect investment," Gale said in the study.
 
It's also important to know how much a tax reform plan will cost to know whether or not it's feasible to expect an economy boom.
 
At this point, the Trump administration doesn't have the details on the tax plan costs.
 
However, an article published in the Columbia Journal of Tax Law said the federal debt would rise by at least $3.6 trillion over the first decade and by as much as $9.2 trillion by the end of the second ten years under the proposed GOP plan.
 
The plan would reduce federal revenue by $3.1 trillion in the first decade of going into effect and by $2.2 trillion in the second decade before considering macroeconomic feedback.
 
A tax policy can increase economic growth but spending cuts have to go hand-in-hand with tax cuts in order to see positive results. 
 
"Cuts in income tax rates that are financed by spending cuts can have positive impacts on growth, according to the stimulation models," Gale said.
 
Big tax cuts vs. small tax cuts
 
President Trump is proposing a major tax cut, which many Republicans are eager to embrace. 
 
However, Democrats are not too keen to jump aboard.
 
Sen. Bob Casey, D-Pa., called the proposal "a massive tax giveaway to millionaires, billionaires and big corporations at the expense of middle class families in Pennsylvania ... It won't create jobs, increase middle class incomes or grow our economy."
 
Additionally, some tax policy experts believe big tax cuts may be harmful to the economy. 
 
Leonard Burman, co-founder of the Tax Policy Center and expert at the Urban Institute said in an email to ABC10.
 
"Well designed tax cuts can spark growth, especially in the short run, and especially when the economy is operating at less than full capacity," he said. "Small tax cuts could continue to boost growth over the long run by improving business incentives to invest and individual incentives to work and save.  Big tax cuts ultimately turn out to be counterproductive, because the rising debt pushes up interest rates, which discourage business investment and purchases of homes, cars, and other big ticket items by consumers."
 
If tax cuts generate more money, where is that money going?
 
There is no way to know how an individual will react to lower tax rates. Neil Irwin from the New York Times, brings up the point, some people could use lower tax rates to work less and earn more if they are comfortable with their income. Others could decide to do the opposite, and work more for more money and less taxes. 
 
If the latter occurs, it could spark an economy boost, Irwin explains. However, if more people decided to work less a tax cut could potentially lead to lower growth.
 
Since the details of Trump's plans are still being hashed out, it's difficult to predict whether or not the economy will see a boost.

© 2017 KXTV-TV


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