Magazine article Business Credit

Timing of Tax Cuts Is Key to Stimulative Impact

Magazine article Business Credit

Timing of Tax Cuts Is Key to Stimulative Impact

Article excerpt

Nothing says holiday like a massive piece of tax legislation. At the time of this writing (mid-December), the plan was on the verge of emerging from the committee charged with reconciling the two versions that passed the Senate and the House. The intention was to bring this to a vote in the following week and perhaps have it signed by President Trump by Christmas. By the time you read this, you will know how well that went.

Lets assume the plan (or something like it) is passed- what does it all mean? Obviously, it is hard to make definitive statements without knowing all the gory details, but the majority of the proposal has been worked out and is now open for discussion. It has been a while since the process started, but it is worth going back to the beginning and determining what the original intent was.

There are many motivations as far as taxes are concerned. At the heart of the taxation system is the need to finance the activities of government. When taxes are hiked, it is generally because the government needs or wants to spend more without going into debt. When taxes are lowered, the assumption is that the government can get by with less money and it would be better to leave the money in the hands of the business community and the taxpayer. It is further assumed that lower taxes will prove to be a stimulus to the consumer and the business community. The primary rationale for this tax cut is that of stimulating.

There are several assumptions being made at the very start. The first is that the economy needs to be stimulated at this point; there are many asserting that it doesn't. The rate of unemployment is as low as it has been in almost 20 years, growth has exceeded 3% for two straight quarters, the majority of employers are struggling to find suitable workers, exports are up and consumer confidence is high. The most likely impact from a tax cut in the short run will be higher rates of inflation, which in turn triggers the Fed to hike rates in order to slow the economy down.

The second assumption is that this tax cut will be stimulative enough to pay for the reduction in revenue. If the U.S. starts to run an even higher deficit and debt, it will have to be paid for with borrowing. That makes the debt worse. The debt ratio is already close to 110% of the national GDP. Anything over 60% is considered dangerous and risky. The deficit currently runs at 3.5% of the GDP and that is excessive as well-3% is considered the absolute maximum sustainable deficit. The Congressional Budget Office has assessed the impact of the tax cuts and has concluded the U.S. economy would need to grow at between 7.4% and 8% to pay for the plan. The estimate of growth from the Trump Treasury is 2.9% per year. That is actually ambitious as most other analysts assert that 2.5% is closer to the truth. To get to the goal of a balanced budget, the economy would need to grow by between 10.1% and 10.2% per year. That is next to impossible for the U.S. economy.

The focal point of the tax plan has been to reduce corporate taxes. It is accurate to state that a U.S. corporation pays a higher corporate tax rate than do companies in most of the other developed economies, but a caveat must be offered. The large U.S. companies very rarely pay anything close to the stated rate of between 35% and 39%. This is due to the fact many of these Fortune 1000 companies can take advantage of subsidies, tax breaks and exemptions. Most of their lobbying efforts over the years have been geared to finding ways to reduce that corporate rate. …

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