(This piece was originally posted on my Patreon page.)
Jim Tankersley had a nice piece in the New York Times last week pointing out that the tax cut pushed through by the Republicans in 2017 is leading to a sharp drop in tax revenue. While this was widely predicted by most analysts, it goes against the Trump administration’s claims that the tax cut would pay for itself.
Looking at full-year data for calendar year 2018, Tankersley points out that revenue was $183 billion (5.6 percent) below what the Congressional Budget Office (CBO) had projected for the year before the tax cut was passed into law. This is a substantial falloff in revenue by any standard, but there are two reasons the picture is even worse than this falloff implies.
The first is that we actually did see a jump in growth in 2018 pretty much in line with what the Trump administration predicted. The tax cut really did stimulate the economy. It put a lot of money in the economy (mostly going to those at the top) and people spent much of this money. The result was that the growth rate accelerated from around 2.0 percent the prior three years to over 3.0 percent in 2018. (We don’t have 4th quarter data yet, which may be delayed by the shutdown, but growth should be over 3.0 percent.)
The jump in growth in 2018 means that the drop in revenue was not due to the economy being weaker than expected, it was due to the fact that the tax rate had fallen by a larger amount than the boost to growth. In fairness to the Trump administration, they had also projected a falloff in revenue due to the tax cut in 2018, but not one that was as large as what we saw.
This gets to the second issue, the source of the revenue shortfall. If we look at the projections from CBO, by far the largest gap between its post-tax cut projections and actual revenue was in corporate income taxes. CBO had projected that the government would get $230 billion from the corporate income tax in fiscal year 2018. It actually collected just $205 billion, a gap of 12.3 percent. This is a substantial shortfall in revenue, especially since this is for the 2018 fiscal year, which ended September 30th. The tax cut was only in effect for nine months of the fiscal year.
The shortfall in revenue from the corporate income tax means, in effect, that the Republicans gave a larger tax cut to corporations than was generally realized at the time. And, since shares of stock are overwhelmingly held by those at the top, this means a bigger tax cut for the rich than advertised.
There is another aspect of this revenue shortfall that is also really bad news. One of the claimed benefits of the tax cut was that it would reduce the amount of tax gaming that corporations do to avoid or evade their taxes. The argument is that we would have a lower tax rate, but with fewer loopholes. This meant that companies would not waste resources trying to get out of paying their taxes and the government could count on getting something closer to the tax rate set in law. (Few companies paid anything close to the old 35 percent tax rate.)
However, the revenue data for 2018 strongly suggest that companies are still putting considerable effort into avoiding their tax liabilities. Apparently, there are still plenty of loopholes that allow them to pay less than the statutory rate. This means that while we did lower tax rates, we did not remove the incentive/opportunity for tax gaming.
As a sidebar, if anyone in Washington ever does develop an interest in preventing tax avoidance/evasion, we do know how to do it. We just require companies to give the government non-voting shares in proportion to the tax rate. For example, if the targeted tax rate is 25 percent we require companies to turn over non-voting shares equal to 25 percent of outstanding shares. These shares would give the government no control over the corporation, but they would be entitled to the same dividends of share buybacks as voting shares. This means that there is no way for the company to escape its tax liability unless it also rips off its shareholders.
These budget numbers are not a big deal for 2018. As I’ve said in the past, it was actually a good thing to see a larger deficit, since the more rapid growth lead to a reduction in the unemployment rate to levels not seen in almost 50 years. It would have been better if the money was used for education, infrastructure, child care or other areas where the benefits would be shared by those at the middle and the bottom.
But, the drop in the unemployment rate means hundreds of thousands more people are working, with the jobs disproportionately going to the most disadvantaged segments of the labor market. Low unemployment has also allowed those at the middle and bottom of the wage ladder to see gains in real wages. And, the low unemployment rate we have seen in the last year set a new benchmark. We now know that the economy can get to an unemployment rate under 4.0 percent without spiraling inflation. Just a few years ago most economists would have argued that unemployment below 5.0 percent would send inflation spiraling.
So, these are positives from the boost in demand from the tax cut, but getting back to the revenue shortfall story, the picture is likely to be worse in future years. As I said earlier, the problem in 2018 was not a lack of growth, the economy had a good year, but revenues still fell. In future years, growth is likely to be a problem.
The Trump administration’s revenue projections assumed that growth would average close to 3.0 percent for the next decade. It did hit this target in 2018, but growth is likely to fall back to near 2.0 in 2019 and subsequent years. The tax cut put money in people’s pockets, which they largely spent. But the one-time boost from a lower tax rate is rapidly coming to an end. If growth falls back to its pre-tax cut trend, as had been projected by CBO, then revenue will be far lower than the Trump administration has projected and the deficit will be correspondingly larger.
The promise, of course, was that the tax cut would lead to an investment boom. This would lead to more rapid productivity growth. The gains from higher productivity growth would be based in higher wages, leaving workers far better off as a result of the tax cut.
To this point, there is essentially zero evidence of the promised investment boom. There was respectable growth in investment in the first two quarters of 2018, but growth slowed to just 1.1 percent in the third quarter. It is likely to be even weaker in the fourth quarter due to the drop in world oil prices (less oil drilling), although we won’t get these data until the shutdown is over. In any case, there is zero evidence that the tax cut is leading to the sort of investment boom that will qualitatively boost the rate of productivity and GDP growth and provide workers with substantially higher pay.
In this context, the deficits from the Trump tax cut are a problem. If the economy is bumping up against its limits and the labor market is close to full employment, it means a much larger share of output is going to the consumption of the wealthy. That both means less private consumption for everyone else, and it makes it more difficult to have major initiatives that involve substantial spending, such as a Green New Deal or Medicare for All.The long and short is that the revenue data for 2018 looks pretty bad on its face. It looks even worse on a closer examination.