This commentary originally appeared in Investor's Business Daily on May 26, 2017.
After suffering from rising federal tax and regulatory burdens, Americans may be on the precipice of the next huge economic expansion.
The evidence is already mounting as business and consumer confidence reach new highs after the Trump administration's regulatory reforms and other pro-growth proposals. The next impetus to support increased prosperity is cutting government spending and taxes.
President Trump's announced tax plan would cut the federal corporate income tax rate of 35%, the highest in the industrialized world, to a more competitive 15%. The plan would also reduce the number of personal income tax brackets from seven to three, double the standard deduction, and eliminate the death tax, Alternative Minimum Tax, and all deductions except for mortgage interest and charitable contributions.
The president's plan is similar to the GOP tax plan but unique in a number of ways. A major difference is the GOP's inclusion of what's been called a "border adjustment tax," or BAT, which is simply a new way of taxing business cash flow.
Specifically, the BAT would keep the corporate income tax base on goods produced and sold domestically but change the base from exports to imports.
One reason for pushing the BAT is to achieve revenue neutrality, which is when tax cuts are offset with increases in other taxes, but the GOP proposal could add to the current $20 trillion in national debt over the next decade.
Moreover, by favoring domestic goods over imported goods, the BAT will distort international trade and its associated benefits, which would harm economic activity.
Some economists favor the BAT, claiming it will level the playing field between imports and exports. Moreover, they speculate that the dollar's value will adjust to the BAT so that it doesn't cause increases in consumer and producer prices or change production patterns.
While these arguments theoretically could happen, they exclude how the BAT would result in less economic growth through at least the following three ways:
- First, the BAT would tax corporate income based on goods imported that aren't taxed today. This would result in taxing income from U.S. companies that import from their foreign ventures, raise their expenses, and reduce production levels.
- Second, the value of the U.S. dollar market is determined by many factors, such as interest rates, fiscal policy, and the markets for goods and services. Therefore, there is no guarantee that the dollar value would adjust to fully negate the BAT's negative effects of raising imported goods prices.
- Third, the BAT would be implemented to provide tax revenue neutrality rather than cut taxes, leaving a higher tax burden than could be achieved.
As an example of the cost of the BAT, the Texas Public Policy Foundation and the R Street Institute commissioned a study that found the BAT could contribute to a cost increase of $3.4 billion in Texas' property-casualty insurance premiums over the next decade from its effect on the reinsurance market.
To avoid these large costs, Congress should focus on cutting taxes while slaying what drives increases in national debt: government spending.
For every dollar of taxes cut, Congress should cut a dollar in government spending. This pro-growth combination would assure no additional increase in projected deficits under current policy.
In addition, this approach would support increased economic growth that would contribute to more taxes collected, resulting in reduced projected deficits.
The starve-the-beast approach, with the goal of reducing the size and scope of government, has been tried before from historic tax cuts under the administrations of Kennedy-Johnson, Reagan and Bush 43. However, in each case, government spending rose faster than increased tax collections, resulting in substantially more national debt.
To reduce the federal tax and regulatory burdens that hinder economic growth this time around, Congress should pursue a "budget neutral" approach of cutting both taxes and government spending.
Fortunately, President Trump's announced tax plan doesn't focus on revenue neutrality by including the BAT. This provides an opportunity for a discussion about taming excessive government spending.
Federal tax reform should focus on core principles of taxation that include a simple, efficient and competitive tax system. President Trump's tax proposal heads in that direction.
By following these principles and focusing on cutting government spending to achieve budget neutrality, without creating a costly BAT, Americans can be more prosperous and optimistic about their future.