By James H. Nolt
The U.S. Republican Party, having failed to “repeal and replace” the Affordable Care Act, has now turned to another important but divisive issue: taxes. President Donald Trump and his party have tried, with limited success, to frame their position on this issue as benefitting those Trump calls the “forgotten people”—hard-working middle and working-class people. Republicans try to pose as a populist party by claiming to champion these “forgotten people” against the lobbyists and insider interests, mostly corporate, that skew Washington in favor of the rich and powerful.
Liberal commentators are immediately baffled that Trump and the Republicans have the audacity to pose as populists favoring the interests of ordinary people when proposals such as this tax plan are so obviously skewed to favor corporations and the rich. Even more baffling for liberals is why so many ordinary Americans do not see through this scam. Liberals and Democrats would do well to look in the mirror. What have they accomplished on tax reform? Part of the reason Republicans like Trump can plausibly pose as populists at election time is that there is no popular alternative offered by the opposition party. Ordinary people may not know all the details of policy analysis, but they do understand that politics is rigged by party donors and that Trump is right when he says people like them are often forgotten in Washington.
One of the many things tax reformers of both parties like to campaign for is tax simplification. This latest proposal claims to “simplify” the tax system by cutting the number of tax brackets from seven to three, although this is merely a way to reduce the top tax rate in the name of simplicity, since looking up how much tax you owe in the tax tables will not be one bit easier if the number of brackets changes. It also proposes cutting out most deductions. The study cited above argues that this will increase the effective taxes on the upper middle class. Actually, the real and necessary complexity of the tax code is beyond the experience of most people. True and irreducible complexity comes from the accounting rules that define what counts as business income and what are legitimate expenses. These affect only corporations and those whose income is mostly from business ownership rather than wages or salaries. This complexity, mostly ignored by all but corporate lobbyists and tax accountants, is where the real massive stakes lie for the rich and powerful. In any tax reform, expect more generous giveaways there. Both parties favor their specific donors in crafting these arcane accounting details.
There does remain one large difference between the Republican and Democratic parties, which is how much to tax versus how much to borrow. Traditional Republican conservatism up through President Richard Nixon favored balanced budgets; in other words, taxation should be sufficient to cover spending. Republican President Ronald Reagan broke the mold, accumulating staggering budget deficits as he instituted massive tax cuts without corresponding budget cuts. Budget priorities were shifted from civilian programs to the military, but overall spending was not cut commensurate with the tax cuts favoring the rich. Most Republicans have followed this pattern ever since, idolizing Reagan in the process. The traditional conservative critique of liberals was that they loved to garner popularity with voters by spending money, but avoided the unpopular burden of imposing the costs on voters by borrowing, instead of raising taxes. This critique appeared to fit the U.S. in the 1960s, as well as Japan and much of Europe at various times in the second half of the 20th century.
Now the shoe is on the other foot. Republicans like to pose as populists by offering “middle-class tax cuts” (though the richest always seem to benefit the most) and giving up on their traditional balanced budget. They complain about many government programs, but they never cut as much as they promise and find new security fears to justify lavish spending, so in the end they give up on balancing budgets like the liberals of the 1960s. Instead of “tax-and-spend” liberals they are “borrow-and-spend” conservatives. As regular readers of this blog will know, I argue that since Reagan most modern Republicans are closer to anarchists than to traditional conservatives.
Nobody likes taxes, but is government borrowing really better for ordinary people? The traditional conservative answer is that borrowing burdens future generations. When I studied economics, typical professors said this old logic no longer applies because debt will just keep growing, so there is no need for future generations to pay it off, as long as the interest burden is not an unreasonable share of total government spending. Lower taxes mean higher growth and therefore more national wealth in the future, so even if debt grows, it might not grow significantly as a share of national wealth. So, is borrowing preferable to taxing? It seems, at least in the short run, it can be more politically palatable.
This series on polarized political economy should remind you that there is not one right answer. Borrowing instead of taxing does have real consequences for the distribution of income and power, but whether it is good or bad depends on who you are and what interests you defend. To understand this issue from all sides, it helps to “think like a capitalist.”
If I run a business, taxes are a net loss of capital. This may be bearable if I believe that what the government does with the tax revenue profits my business, but taxes are a capital loss, a drain. On the other hand, if the government borrows from me by selling me a Treasury bond, my capital is undiminished. I gave the government cash for the bond, but I can either hold the bond and get paid interest, meaning that that portion of my capital still earns profit for me like any other portion, or it can sell it and recover my capital that way. Either way, when I loaned money to government, I lost no capital; when I was taxed instead, I did shed capital. All else being equal, business prefers government to borrow rather than tax.
Such borrowing increases the government’s ability to spend (hiring employees and buying things) without diminishing business’ ability to invest. Traditional conservatives argued that there was a “crowding out” effect, assuming that there is a fixed pool of savings that borrowers compete to borrow. Therefore, if the government borrows more, business must have less capital available to borrow. But this is wrong. Contemporary anarcho-conservatives have realized that government borrowing does not necessarily come at the expense of business borrowing. It can merely result in a net increase in total credit, in other words, an increase in buying power.
What increased borrowing, public or private, does do is increase the income and power of financial interests and feed into the roller-coaster business cycle. Expanding credit is bullish, and raises aggregate demand and typically some prices (the devil is in the details). It is great for bulls and for financiers in the credit business. But it does have limits. Debt creates powerful opposing bear and bull interests. The limits of debt financing may manifest much sooner than our grandchildren’s lifetimes. Business cycles turn in a decade or so, not over generations. Next week I will explore a potent and illustration of the dangers of “borrow and spend” that is recently in the news: Puerto Rico.
James H. Nolt is a senior fellow at the World Policy Institute and an adjunct associate professor at New York University.
[Photo courtesy of Chris Potter]