The net effect of the Republican tax proposal introduced in late September is more debt with little to show for it, according to an analysis by economists at Moody’s Analytics led by Mark Zandi.
Building on an earlier analysis by the Tax Policy Center, the Moody’s economists found that over the 10 years from 2018 through 2027, the Republican plan would cost $2.4 trillion in reduced revenues and increase interest rates but add only 0.04% annually to GDP.
Payrolls would rise slightly and the unemployment rate would inch lower, but the stock market would be flat except for a 4.8% gain in 2018. The 10-year Treasury rate would rise 74 basis points annually over the 10 years through 2027, and the federal funds rate would increase 30 basis points — both having the effect of slowing growth.
The federal deficit would increase to over 5% of GDP from about 4% currently and the total debt to GDP ratio to 93.5% from 85% currently. In addition, increased government debt issuance to finance the deficit would crowd out some private corporate debt.
“The plan doesn’t do much for the economy,” said Mark Zandi, chief economist at Moody’s Analytics during a webinar focused on the potential impact of the plan.
It does however, do a lot for corporations, whose top marginal tax rate would drop to 20% from 35% and who would be able to deduct business expenses immediately rather than over several years.
Multinational companies would benefit from changing the current global system to a territorial system for taxing foreign earnings, essentially moving from taxing foreign-source income when it is repatriated to the U.S., with a credit for foreign income taxes already paid, to one where companies only pay taxes on income earned in the U.S.
But the accelerated deduction for business expenses as soon as they’re incurred, known as immediate expensing, ends after five years and the plan itself sunsets after 10 years, in order to qualify for Senate passage with a simple majority rather than two-thirds of the vote, which also limits its effectiveness.
The ultimate impact is a more cyclical economy with growth accelerating in the first year or two, then slowing, leaving an economy more vulnerable to recession, said Zandi.
Overall, “the Republican plan is a boon for business but a wash for individuals,” said Zandi. It reduces the personal income tax brackets from seven to three with the bottom rate set at 12%, up from 10%, and top rate set at 35%, down from 39.6% (though an additional fourth rate could be added for the highest earners).
It also eliminates the Alternative Minimum Tax for individuals, doubles personal tax deduction and eliminates many (undefined) deductions, though it says it would spare the write-offs for charitable donations and mortgage interest. The rate on income from pass-through entities such as S corporations and LLCs would be cut to 25% from what is currently the business owner’s personal income tax rate, which could cause some business owners to restructure their companies to take advantage of the change.
Itemizers with adjusted gross income between $150,000 and $300,000 would pay more if the deduction for state and local income, property and sales taxes was eliminated, according to the Tax Policy Center. Those with adjusted gross incomes above $730,000 would see a tax cut of about 8.5%.
Some Republican senators are reconsidering an outright elimination of the state and local tax deduction, which under the current plan adds $1.3 trillion in federal revenues and essentially pays for a good chunk of the plan’s tax cuts.
“The Republican tax plan will not become law,” said Zandi. He gives 5% odds that the plan will pass Congress.
Before any tax cut or tax reform plan passes, Congress needs to pass a budget resolution that includes the impact of the tax changes on federal revenue. Then the bill would only require a majority vote in the Senate (a minimum of 50 senators plus the vice president) and not be subject to a Democratic filibuster.
The House passed a $4.1 trillion budget resolution Thursday that includes more than $5 trillion in spending cuts over the next decade, including $1 trillion in Medicaid spending. It incorporates many tax cuts but assumes they will not reduce revenue because the cuts will lead to a comparable increase in revenue.
The Senate Budget Committee has released its own budget resolution, which includes tax cuts that it says will add $1.5 trillion to the deficit over 10 years.
The final version of the tax cut bill is expected to more closely resemble the Senate version, which is less generous than the House version and includes a 25% corporate tax rate and 30% rate on pass-through income. Zandi gives 20% odds of the Senate plan passing, 45% odds for no tax reform and 30% odds for passage of a baseline plan Moody’s has developed, which focuses primarily on corporate tax cuts, including a 28% tax rate and territorial system, plus repeal of the AMT.
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