By Kailash Khandke

Frederick W. Symmes Professor of Economics, Furman University

On Dec. 20, 2017, Congressional Republicans passed one of the biggest tax cuts in nearly three decades. The White House makes the argument that this will create rapid economic growth and new jobs, increase wages, and put more income in the hands of a large majority of Americans. Hence the so-called official moniker, Tax Cuts and Jobs Act of 2017 (TCJA). There are a number of substantial changes in the tax brackets, itemized deductions, child tax credit, alternative minimum tax, and estate tax changes, to name a few. For a detailed description on the various components of the tax reform, see https://www.congress.gov/bill/115th-congress/house-bill/1/text. In this article, I will focus on just some of the stylized and main changes in the TCJA.

The new overhaul in the tax code is likely to influence both individuals and corporations starting in 2018. On the corporate side, the rate falls from 35 percent to 21 percent. For individuals, there’s a change in the tax brackets—a drop from 39 percent to 37 percent for those earning more than $500,000, 28 percent to 24 percent for those in the $165,000-$315,000 range, and from 25 percent to 24 percent for those earning between $77,000-$165,000. The standard deductions for those not itemizing increases from $12,000 to $24,000 for married filing jointly, and for single filers the number increases from $6500 to $13,000 for 2018. Perhaps the most dramatic change is in the state and local tax deduction (SALT).  Previously unlimited for those itemizing deductions, the new tax bill limits state property and income and sales taxes that can be itemized to $10,000.

Is the new tax bill a much-needed tax cut and will it substantially accelerate economic growth in the United States? This is the billion-dollar question (pun intended). That the corporate tax cut is long overdue is a sound argument, and the 21 percent rate is much more in line with rates in other industrialized countries. Furthermore, the thinking is that corporations such as Apple and Google will spend on new capital equipment, increase expenditure on R&D, and raise wages for their employees. Critics argue that the tax savings will lead to corporations buying back their own stock, issuing higher dividends to shareholders and investors. In fact, the evidence from a similar 2004 tax holiday suggests that corporations repatriated a sizable $300 billion dollars of earnings they had parked abroad in lower corporate tax economies, but it did not lead to increased investment or have large employment effects. Nevertheless, to the extent that the corporate overhaul incentivizes repatriation of profits and earning abroad, there may well be some positive short-term U.S. growth prospects.

The provision to cap the itemized deductions for state and local taxes to $10,000, coupled with the increase in the standardized deduction, could have some major ramifications on the behavior of individuals. For example, will individuals decide not to itemize their deductions and take the standard deduction, which is now 100 percent higher than in 2017? Before 2018, the tax code incentivized charitable giving for those itemizing deductions. The non-partisan Tax Policy Center (TPC) estimates that charitable donation may drop by 50 percent over the next three years, since individuals will opt for the standard deduction. While the mortgage-interest deduction provision is largely unchanged, the tax incentive to buy a home is certainly dampened. Whether new entrants into the workforce who wish to buy a home will take the standard deduction and ignore the perceived benefits of writing off the mortgage interest as an itemized deduction remains to be seen.

Economic theory argues that a tax cut increases disposable income and leads to more aggregate demand for goods and services, thus boosting Gross Domestic Product (GDP). Well-conceived tax reform could promote growth. The White House and the Republican Congress is betting on the tax cut delivering a sustained 3-4 percent economic growth after a decade of close to 2 percent growth. Yet, as this author argued in a previous column (January 2017), in today’s integrated global world, booms are the exception rather than the rule. Moreover, in 1990, President George H. W. Bush raised taxes, and growth was steady over the next five years. In 2001, President George W. Bush cut taxes, and the economy had a lackluster performance before the Great Recession set in. This is by no means suggesting the counter-factual: that raising taxes raises GDP, and cutting taxes necessarily lowers GDP. What it does suggest is that the economy is complicated and policymaking involves more than the institution of Congress. The Federal Reserve as an independent institution and in its conduct of monetary policy has some statutory mandates that include maximum employment, stable prices, and moderate long-term interest rates. Ever since the oil price shocks of the 1970s, the Fed has been wary of inflation and in 2012 instituted a 2 percent inflation target. The Fed has recently announced that it is prepared to raise interest rates if it thinks inflation is on the horizon. Should the tax cut lead to economic growth of between 3-4 percent, the Fed may launch a preemptive strike against inflation by raising interest rates, choking corporate borrowing, thus mitigating the influence of the tax cuts on the economy. In any event, since the TCJA is a fairly comprehensive and ambitious overhaul of the tax code, it may take at least 2-3 years for corporations, individuals, and individual states like South Carolina to fully adjust to the new tax laws.