Critics have already said President Donald Trump and congressional Republicans’ tax reform plan will do little to improve economic growth, will expand the federal debt, and could crimp the government’s ability to stimulate the economy when the next recession hits. Despite this negative reaction, most analysts have contended that the GOP plan is business friendly.
But the plan is also bad news for the private sector—and most Americans along with it.
The first problem is that the plan, while providing a lower corporate tax rate, will actually hinder business. The GOP proposal lowers taxes on companies with the aim of improving competitiveness and keeping them from moving abroad. Both the Senate and House plans propose dropping the corporate tax rate from 35% to 20%. The House plan will reduce tax revenue by more than $200 billion a year over the next few years, with total cuts amounting to $1.5 trillion over the next 10 years. In addition, a Wharton School report shows that the Republican tax bill will add $29 billion to the federal deficit by 2028. The current deficit for fiscal year 2018 stands at $440 billion.
This might sound like good news for business. But periods of economic growth are normally when deficits shrink. During the current period of economic growth that began in 2009, the deficit has kept growing.
Lower tax revenue and a ballooning deficit will put pressure on discretionary government spending, or at least cause it to lag growth in the population. Discretionary spending is a source of valuable public investments in infrastructure, science, health research, and education, which carry long-term benefits to business and society in general. Infrastructure spending is also a means for the government to stimulate the economy during recessions. With less discretionary spending going forward, the government will be limited in its ability to stimulate the economy during the next downturn.
The current federal fiscal scenario is reminiscent of the George W. Bush administration’s tax cuts, which included lower tax rates for dividends and capital gains and mostly benefited the wealthy. These cuts proved to be of no help when the economy entered dire straits during the 2007–08 fiscal crisis, and the Great Recession that followed. The federal government was hamstrung in 2009 and 2010 because of the size of the deficit.
There is another reason for concern over the Republican tax overhaul: It will likely exacerbate inequality of income distribution. Beyond the moral implications of widening the gap between haves and have-nots, OECD research has shown that income inequality actually hurts the overall economy. For example, Italy, the U.K., and the U.S. lost out on six to nine percentage points of economic growth over the two decades leading up to the Great Recession because of increases in income inequality. Leaving behind an entire class of consumers and potential consumers is bad for business—to say nothing of societal implications that link poverty to crime and greater risk of substance abuse.
While business leaders may cheer the prospect of paying lower taxes on corporate profits, the GOP plan should make them think twice. The longer-term implications may undermine growth and cause more harm than good at a time when the U.S. should be improving fiscal management and paying down its deficit.
David Besanko is a professor at Kellogg School of Management at Northwestern University.