“We’re proposing one of the largest tax cuts in history, even larger than that of President Ronald Reagan. Our tax cut is bigger.”
That was President Donald Trump speaking on May 1 in a speech made to the Independent Community Bankers Association at the White House, promising huge, record-setting tax cuts for the American people this year.
Since 1968, the largest tax cut in American history was the 1981 package delivered by President Ronald Reagan, a Republican Senate and a Democrat House. At its height, 4 years after enactment in 1985, it rose to 4.1 percent of the Gross Domestic Product (GDP), averaging 2.89 percent of GDP over the four years post-enactment, or $111 billion a year, according to data compiled by the U.S. Treasury official Jerry Tempalski in 2006.
Back then, the size of the economy from an average nominal GDP from 1982 to 1985 was $3.8 trillion. Today, the economy is much larger — in no small part thanks to the tax relief Reagan provided — at $18.6 trillion.
If you take the 4-year average of the size of the 1981 Reagan tax cut and apply it to today’s economy as a percent of GDP, to enact tax relief at least as large as Reagan’s in terms of its impact on the economy by lowering corporate and individual rates, at 2.89 percent of GDP, would require average revenue reductions $536 billion a year, or about $5.4 trillion over 10 years.
Nominally, that would be the largest tax cut ever, and proportionate to the economy, as large as Reagan’s as a percent of GDP.
But here’s the hitch. Whatever tax bill moves in Congress will be via the budget reconciliation process, which under the Byrd rule — which Senate Republicans remain reluctant to overturn — will have to be deficit-neutral. We can argue until we’re blue in the face about how tax relief will boost GDP over the long-run and increase revenues, but so long as Congress allows the budget score to bank a tax cut as adding to the deficit, that’s how this process is going to work, right or wrong. It’s going to be a budget reconciliation bill, and the budget score is not going to be great when it comes to the tax cuts.
Meaning, to get a tax cut even half the size of Reagan’s commensurate to GDP, at 1.45 percent of the economy, or $2.7 trillion over 10 years, will require offsetting spending cuts and revenue increases of exactly that size over the next 10 years.
So, it’s all about the budget.
How big is the tax cut? It depends how much deficit reduction the Congress-passed budget can achieve. This means the ball is in the court of the House and Senate Budget Committees. The bigger the spending cuts, the bigger the tax cut can be. If nothing else, using spending cuts is far more economically advantageous than, say, eliminating capital gains treatment for carried interest or ending full expensing of advertising expenses or gutting the mortgage interest deduction.
However, what’s on the table right now is not so promising. Repealing Obamacare was supposed to be the basis of much of the spending cuts that opened the door for tax reform, but thanks to Sens. John McCain (R-Ariz.), Susan Collins (R-Maine) and Lisa Murkowski (R-Alaska), not even the so-called “skinny” repeal could pass.
The House has a budget, but it only cuts $203 billion over 10 years, which is not big enough. It only works out to about $20 billion for potential tax relief every year, just 0.1 percent of GDP. That is, less than a tenth of a percent of the economy. That wouldn’t be “one of the largest tax cuts in history,” it would be one of the smallest, and if that is all Congress delivers, it will surely be a disappointment.
Fortunately, President Trump put forward a budget that cuts spending $4.5 trillion over 10 years, which Congress must take a look at to become the basis for achieving significant tax reform that can actually make a dent in the slow growth that has plagued the U.S. economy for years. It made no assumptions about revenue. That was after the tax plan Trump outlined on the campaign trail in 2016 was scored by the Tax Foundation as a $4.4 trillion plan. Therefore, the $4.5 trillion of budget cuts were designed to offset a likely budget score from his tax plan.
The President’s message to Congress is clear. Want a big tax cut? Cut spending.
Or, maybe, change the rules, as Americans for Limited Government President Rick Manning noted in statement, saying, “Congress and specifically the GOP Senate face a choice. Either, end the Byrd Rule requiring deficit neutrality on budget bills, or enact the Trump budget that cuts $4.5 trillion of spending to make room for the tax relief the American people and businesses need to get the economy moving again. The Byrd rule which allows the parliamentarian to effectively veto any part of a budget reconciliation bill is nothing more than an excuse, because the majority can overrule the parliamentarian on anything, meaning they can do whatever they want.”
Manning added, “Otherwise, the tax bill likely to emerge from the House and Senate is going to stink, just like the economy has for the past decade or so.” He’s right.
The U.S. has not achieved above 3 percent growth since 2005, and not above 4 percent since 2000. To restore robust growth, Congress has to help keep President Trump’s promise and think big on tax cuts. That means delivering a budget that gives enough room with big spending cuts for major tax cuts over the next decade — which should be in the trillions not billions — or change the rules. If not, then things could start to get bumpy economically. The thing to watch is the budget.