Now that the US Senate has passed the tax reform bill, what happens next?

The two key economic questions are these: Is this really a move to a better tax system? And will it really be revenue-neutral?

Hamish McRae
Saturday 02 December 2017 16:39 GMT
Trump praises 'tremendous reform' after tax bill passes giving cuts to America's richest

For Americans the US tax cuts are – depending on their political perspective – a move towards a saner and simpler tax system, or a hand-back of taxes to the undeserving rich that load future generations with more national debt. To outsiders, this looks like the US bringing some aspects of its tax system closer to the global standards common in the rest of the developed world.

The Senate passed a bill in the early hours of Saturday morning that differs in detail from that passed by the House last month, but has broad common elements.

What happens now, to explain to non-Americans, is that the two bills go into conference. Congress appoints a temporary committee that considers the two versions of the bill and resolves the differences. This is standard practice and there is no reason to suppose it won’t be successful. Even if there are large-scale ructions associated with the President and his family’s conduct between the election and his taking office, Congress continues to do its job, and there is a good chance that this will be law by Christmas.

There is a temptation to see this in political terms: have the Republicans won a victory that will help them in the mid-term elections next year? But the two key economic questions are these. Is this really a move to a better tax system? And will it really be revenue-neutral, as the Republicans claim, or will it add billions to the national debt?

As far as the move to a better tax system, in one regard the answer is surely yes. That’s the cut in the headline rate of corporation tax from 35 to 20 per cent. It makes no sense at all to have a much higher rate of corporation tax than most other developed countries. (The Dutch are cutting their rate to 21 per cent right now.) It particularly makes no sense when you also have zero tax on the profits of companies that make those profits abroad. Not only has this been a bizarre incentive, but it has favoured the largest and most sophisticated firms and encourages them to build the complex web of overseas subsidiaries that enables them to avoid paying any tax at all on some of their income.

US Senate passes tax cuts for America's richest in late-night vote

The original idea was to couple the cut in the tax rate with the requirement on companies to repatriate those foreign balances, perhaps with a lower tax rate on these profits, and charge tax on future profits. I am not quite sure what has happened to that, as I must confess to being bemused by the great wodge of crossings-out and handwritten additions to the draft. If the final form, after the conference process, means that foreign profits will be exempted from tax, then a lot of people who would like to see a fairer tax system will be rightly disappointed. The US does not get many shots at radical tax reform, and it would be really pretty dreadful to allow such a huge loophole to continue. But let’s wait for the detail before making a judgement.

The other potentially positive element is the simplification of the personal tax code. I know some opponents of the bills fret about the small cuts in the tax rate for top earners, but actually the bane of the US system is the range of things the rich can do to avoid paying hardly any tax at all. Reducing the scope for “deductibles”, things that people can use to reduce their taxable income, will be much more effective. There seems to be quite a bit of movement here, but again, let’s see the final form of the legislation before making a judgement.

What about the charge that this whole package will add to the national debt, with the figure of $1.4 trillion (£10.3 trillion) being cited?

There are, I suggest, two things to be said here. The first is that we really do not know whether these tax changes will result in faster growth, as Republicans claim, or that this growth will make the measures tax-neutral.

The economic models suggest that these tax cuts will increase the deficit, so anyone saying they won’t has to either declare those models wrong, which they may be, come up with some other new information about human or company behaviour that overrides past outcomes. It is no good just asserting that growth will happen because that is what you believe is true. Frankly I don’t see a lot of evidence that the US economy is held back by high taxation. I think it may to some extent be held back by badly constructed taxation, but that is another matter. Put at its lowest, unfunded tax cuts are a risk.

The second is that large and persistent government deficits have been a feature of most democracies since the Second World War, and that the resulting debts will be an increasing burden on future generations. The US is no better, and no worse, than the rest of us in this regard. But it has been able to get away with persistent deficits because of its relatively favourable demography, the vibrancy of its commercial sector, its national resources and the position of the dollar. The world cuts the US more slack than it does other countries.

Ultimately, though, debts have to be serviced, even those of the US government.

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