Chicago Booth Review Podcast Trumponomics: Do More Tax Cuts Make Sense?

Eric Zwick: Provisions that seem to have the highest bang for buck intuitively are those that actually affect decisions that are right at the cusp of being taken or not, like new investments or research and development type innovative investments. And we put in some of those incentives, but those are also phasing out now, we should probably continue those. And if we need to find money moving the corporate rate back up, would in some sense generate a bit of a free lunch.

Hal Weitzman: This year, we're likely to see a lot of congressional wrangling over tax cuts. Many of the provisions of the 2017 Tax Cuts and Jobs Act, the biggest corporate tax cut in US history will expire this year unless they're renewed. But do tax cuts actually produce the economic benefits that their proponents claim? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman. Today we're continuing our Trumponomics series in which we give you the Chicago Booth Review perspective on the White House's economic policies. Chicago Booth's, Eric Zwick and his co-authors conducted an extensive study of the 2017 tax cuts. Did they as all tax cutters claim pay for themselves and what would he do differently when it comes to taxing corporations and individuals? Eric Zwick, welcome to the Chicago Booth Review Podcast.

Eric Zwick: Thanks for having me.

Hal Weitzman: Timing is everything and we are here talking about tax cuts, which are very much back in the news, and that's your area of expertise. We had to have you on to talk about it. There is talk about extending the tax cuts that were put in place in 2017, the first term of the Trump administration, and you've done a lot of research about what that means, whether they actually... Taxes always pay for themselves, don't they? Like laundry always does itself, and food cooks itself and...

Eric Zwick: Lots of free lunches in economics.

Hal Weitzman: Exactly. So let's dig into that because, of course, things don't pay for themselves despite the promises. So, remind us what happened in 2017. What were the big provisions and what were the effects?

Eric Zwick: So there are two sides of the 2017 Tax Reform. There's a side affecting primarily businesses, corporations, and there's a side that is on the individual side, so sort of thinking about people earnings, their income, and so on. So the 2017 tax cut, there was a large corporate tax cut. The rate was 35% before, it went down to 21%. So it's 14 percentage points, which is the largest statutory rate reduction in US history. And there were a bunch of other provisions to try and incentivize investment, and also international provisions to try and discourage firms from shifting profits and activity abroad.

A lot of those provisions are actually made permanent. There were some components of the corporate reform that was temporary, but many of them were made permanent. So the things that are expiring now are mostly on the individual side. So individual tax cuts more at the top, top 1% benefited quite a lot from those individual rate cuts. A little bit on pass-through businesses, which are part of the individual tax code, but then also simplifying reforms on the individual side, like an increase in the standard deduction, caps on how much you can deduct state and local taxes. All those individual provisions are expiring this year.

Hal Weitzman: So some of those provisions are pass-through provisions, aren't they, for people who have their own LLCs or whatsoever?

Eric Zwick: That's right. So pass-through businesses, which is more than half of employment. A lot of income is taxed on the individual side, not on the corporate side. And so there was a pass-through tax cut that's part of the TCJA in 2017, and that sets to expire as well.

Hal Weitzman: TCJA meaning, which is the name of the bill?

Eric Zwick: That's the name of the bill. The formal name is some budget reconciliation mumbo jumbo because of house rules or congressional rules.

Hal Weitzman: So instead of mumbo jumbo, we call it TCJA.

Eric Zwick: Yes, that be called something else.

Hal Weitzman: Yeah, more mumbo jumbo. Okay.

Eric Zwick: Yeah, an acronym. Yeah.

Hal Weitzman: So the individual provisions of the part that we're talking about that what's-

Eric Zwick: [Inaudible 00:04:13] primarily going to expire.

Hal Weitzman: There'll be some attempt to renew that this year and maybe go deeper. So, it sounded like from what you said, the beneficiaries are mainly people with higher incomes?

Eric Zwick: Yeah. So, corporate stock is primarily held in the top half and even within that it's concentrated in the top decile with even in that concentrate at the very top. And so, a large corporate tax cut is going to benefit those people more than folks in the bottom half or in the middle. The individual tax cuts were pretty broad, but the marginal rates are increasing at the top in the way that they were cut. In terms of dollars, much more of the dollars went to focus in the very top of the income distribution in terms of the tax cuts.

Hal Weitzman: Okay. Because sometimes you hear the criticism that that was basically just the tax cut. I mean, that's the Democrat line, isn't it? That was the tax cut for the rich at the expense of the middle class.

Eric Zwick: That's right.

Hal Weitzman: Are you saying that's somewhat correct?

Eric Zwick: That's somewhat correct, but it is also the case that most people received some tax cut on the order of a few percent of income at the time. The main exception is folks living in high tax blue states who no longer get to deduct their income and property tax at the full amount. And so, if you're in the 95th percentile of the income distribution in states like New Jersey, Illinois, California, you may have actually seen a small tax increase, but that's a relatively small fraction population.

Hal Weitzman: Okay. So for most people though, this was a tax cut. So in that sense, I suppose the Trump administration achieved what it wanted to achieve, but you were looking at the cost and benefit, what we actually got from the tax cut apart from money in people's pockets. So what did you find there?

Eric Zwick: Right. So one of the big selling points of the reform, as other than people like tax cuts and that happened. People like them, but they cost money.

Hal Weitzman: No one likes to pay tax.

Eric Zwick: Right. It's a necessary evil as most people understand it. But we do also like government services and so we have to pay some of those with taxes. But folks argued that especially on the corporate side of the ledger for those corporate tax cuts, that some of the initial loss in revenue would come back through higher growth, and that higher growth would generate more tax revenues. And so, some of it would pay for itself. Some of the most extreme projections were that it would be so dramatic, the growth response that the full cost on the corporate side would be offset. And so, we sought to try and dig into that question using some research methods to see, "Well, how did the numbers shake out?"

Hal Weitzman: Okay. And so what did you find?

Eric Zwick: So we found substantial growth effects on the order of investment right after the reform increasing by 5 to 15% across a range of methods. And not even just looking at our study, looking at other studies that have tried to use different approaches than what we took. So say, 10% on average investment response over the first few years, then there was a pandemic. So it's a little hard to think about using precise research methods to separately identify that effect from everything else going on. But then, if you take that 10% out over 10 years using a model to think about disciplining what that 10% means in the long run, we get a 5 to 7% increase in capital accumulation relative to no tax cut. So that seems like, "Okay, great, let's map that growth into [inaudible 00:07:49]. Great.

Hal Weitzman: Job done, investment achieved.

Eric Zwick: Yeah. But let's now compare that to the cost. So, that's going to generate some higher profits. Of course, we have more deductions for investment that's being done, so that's going to wipe out some of those higher profits for tax purposes. But then we have higher output, more payments to workers, more dividends to owners that's going to generate extra tax revenues. Let's add that up over 10 years. That offsets something like 15% by year 10 of the mechanical loss. So the mechanical loss is like a 40 percentage point reduction. So say, we were collecting 300 billion in corporate tax collections, that's like 120 billion loss. And we're saying about 10 to 15% of that comes back through these spillover effects from higher growth. So that's not nothing, but it means that the reform still has considerable cost.

Hal Weitzman: It didn't do what promised, right? It was expensive and it didn't achieve what it was supposed to achieve. That's basically, the...

Eric Zwick: I think for the folks that were arguing that this would cost nothing, that's not what the data looked like.

Hal Weitzman: So that's why I said at the beginning, it always pays for itself just like laundry always cleans itself. At least that was what I remember from my student days. So, I'm just wondering because I'm British, in the UK, Liz Truss was a very short-lived prime minister who had the same idea. "We'll just borrow a whole load of money, cut taxes, and suddenly the economy will grow," and the bond markets didn't like it and she had to leave very quickly. Because does it ever pay for itself? I mean, I know you've done these very careful calculations that you talked about, but... I mean, do you think in general that is a legitimate claim to make that tax cuts pay for themselves?

Eric Zwick: Very rarely do they fully pay for themselves, but some additional growth might be worth it. It's sort of like, we buy lots of things as a government that we don't collect revenues coming back to us to offset those initial costs, and we just choose to do those things because we think it's worth it, socially. Tax cuts are in this funny world where maybe some people will say, "Well, it's actually free because there's enough growth that comes back that it's not actually costly." We're on the wrong side of what they say, the Laffer Curve, we're actually cutting tax is not only reduces the burden on folks that are paying those taxes, but actually causes them to work enough to offset the direct mechanical loss. And we're saying, "Well, that's not really what it looked like here." So there is money left on the table that crowds at other programs.

Hal Weitzman: I guess, this is partly why people hate economists, right? Because it seems really hard to know in advance. It's a bit like interest rates. You don't know exactly what the response is going to be, whether people are going to get the message or going to behave in the way that you want them to behave. So, do you think we can ever really know in advance the effect that tax cuts are going to have?

Eric Zwick: We're not going to know the point estimate. I do think if you look at the range of forecasts at the time, especially from the official scorekeepers or other less partisan institutions that were doing forecasts, they weren't way off. There's some components that are relatively novel and we just have a wider uncertainty band around those novel components of the international side like I mentioned. But I think there's a realm of known unknowns here, there's uncertainty. And it's not, "Let it rip anything go as we can just choose our assumptions." I think there is some discipline. Those forecasts weren't that far off.

Hal Weitzman: Now, I know you have some thoughts about what should have been done instead of that law, instead of that tax cut or that tax cut package. Tell us what you think they should have done instead back in the first Trump administration.

Eric Zwick: Right. One way to think about this is the bang for buck for individual policy, so take the thing apart. There's the rate cut, there's accelerated depreciation incentives for equipment investment, there's R&D incentives, changes in those. There are some of the international provisions. The provisions that seem to have the highest bang for buck intuitively are those that actually affect decisions that are right at the cusp of being taken or not, like new investments or research and development type innovative investments. And we put in some of those incentives, but those are also phasing out now. We should probably continue those. And if we need to find money, moving the corporate rate back up would in some sense generate a bit of a free lunch because the growth effect relative to the revenue effect for the corporate rate is smaller.

And the reason for that is because the corporate rate benefits those new investments. So it has an effect on behavior but also benefits a lot of investments that are already undertaken. So, it's more of like a transfer handout. And that's why we see the stock market respond positively to these corporate tax cuts and more so for firms that benefit more from those corporate tax cuts. So that's one example of dialing the levers in one direction, I think, could generate more growth for the same cost. That's all on the corporate side. On the individual side... Yeah.

Hal Weitzman: So the headline is keeping the incentives for investment and removing just the straight old tax cuts?

Eric Zwick: Yeah, yeah, or I think reducing them, shrinking that size of that tax cut. So instead of going to 21, if we'd gone to 25 or 28, we would've saved a fair amount of tax revenue and probably some of the international incentives that we were concerned about with our 35 rate initially like tax competition across countries would've been addressed by going to that rate. On the individual side, there's less growth effect. There's a direct demand. People have more money in their pockets, they spend more. In weak economic times that might make sense, in low inflation times that might make sense, in low interest rate times that might make sense. We're not in those times right now.

So, letting some of those individual tax cuts expire would be fiscally quite prudent and would have limited effects on the economy right now in terms of growth. So, there's some simplifying components of the individual reforms like the standard deduction being increased, which moved a bunch of people from itemizing their taxes to just taking that standard deduction. That's a simplifying reform that enjoys wide support from everybody except for maybe TurboTax in the accountant's lobby. But I would like to see that continue, and the individual tax cuts, I think we could make them a lot more targeted than they were legislated. But I'm not optimistic that's how things will transpire. We'll see.

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Eric, in the first half we talked about the 2017 tax cut, the tax cut from the first Trump administration, which they're hoping to renew. And you said, what you would've done differently. And now, I guess, we're in 2025 and we have a chance to do things a bit differently. And I think I can summarize your advice as basically being, we don't need to keep tax cuts in place for corporations or individuals who pass through laws, but we do want to encourage investment and simplify things as well. However, none of that seems likely to happen. Let's face it. The momentum is probably to try to renew them, I guess, these tax cuts. And there's a proposal right now as things stand, the House of Representatives to make $4.5 trillion of tax cuts, which is, I guess it's mostly the extension, right, of the existing cuts?

Eric Zwick: Yeah. I think that's the forecast cost over 10 years of extending the 2017 cuts. On the individual side, probably 4th that 10 year period, probably not to make it permanent would be my guess. And maybe with some tweaks at the margin to get within that budget that they've set.

Hal Weitzman: Okay. And then, we're going to have to borrow $4 trillion to pay for it?

Eric Zwick: Yes, at positive interest rates, which is quite different than where we were in 2017.

Hal Weitzman: Right. Okay. So that's going to be expensive. So that changes your calculations simply. And then we're going to have to cut spending by a lot of money, 1.5 trillion, 2 trillion, something like that in order to make the... Of course, this is just an initial proposal as we're talking right now.

Eric Zwick: Coming out of the house, exactly

Hal Weitzman: Right. And everything will change, but it just gives you an indication that the mood is, of course, Republicans control, they feel like they've got a big mandate and they feel like the mandate is to continue with these tax cuts. In fact, I think there's going to be some suggestion that the tax cuts should go further. And the president said, he wants corporate taxes to go down to 15%. Given what we know, you've done these sums, your calculations about what did last time around. As you say, we're in a totally different environment now. What effect do you think this would have, if we just did nothing but extend them, just maintain the status quo. What effect is that going to have on the economy?

Eric Zwick: It will be somewhat inflationary because you'll have increased demand from the individual tax cuts being extended relative to a baseline where they weren't. And we're already in a place with inflation that's sort of above target and very low unemployment and interest rates that are considerably away from the zero lower bound. We were closer to that back in 2017. So, putting more money in people's pockets is going to put more pressure on the economy there.

And so, that will put pressure on also monetary policy to try and offset it. So, growth effects are going to be weaker on the individual side than they were in 2017. On the corporate side, reducing the rate further, well, we're already at a pretty low rate. And so firms are, if you think about them as being distorted by corporate taxes away from some romantic ideal of what the capital stock should be, the lower that rate gets, the closer they are to the romantic ideal. And so reducing the rate, another percentage point is going to have a smaller effect on the cost of capital for them, and it's going to have a smaller effect on growth for them.

In addition, the distance or the difference between our system and the international alternative, that was sort of the motivation for a lot of the multinational reforms. That's a smaller gap now, a smaller wedge between domestic and international taxes. And so, reducing the rate further is going to have a smaller effect also on that inbound response that maybe we would've expected in 2017. So for a bunch of reasons, I think the expectation is that it will be costly and generate smaller growth effects than even 2017's reform did.

Hal Weitzman: Okay. So, the diminishing marginal returns just going to get less bang for our buck the more we cut.

Eric Zwick: That's right.

Hal Weitzman: So we've pretty much cut, there's nothing more we could cut out of corporate taxes anyway that would have any significant effect on the economy.

Eric Zwick: Yeah, and we're getting there. I mean, as I mentioned, there is this phasing out of expensing and there was also a shift to a less generous treatment of research and experimentation R&D spending. And so, we could go back to that expensing regime or accelerated depreciation regime, and that would have some effect on growth through increasing the incentives to invest. It would be weaker though, I think, than where we were in 2017 because those things also depend on the level of the tax rate. So a tax write off is more valuable if the tax rate is higher. So there's an interaction there, but those would be a few things that might have an effect on growth.

Hal Weitzman: Well, that's such an interesting point. Yep, of course, so there's no point in giving people incentives if the tax rate's very low or they have less effect. [inaudible 00:20:22].

Eric Zwick: That's right, it's a smaller write off. So, there's a smaller incentive there.

Hal Weitzman: Okay, fascinating. So, let's imagine you talked about the romantic ideal of... It's interesting, I've never heard romance talks when corporate taxes, but the romantic ideal-

Eric Zwick: Valentine's Day, that's we're doing romance.

Hal Weitzman: The romantic ideal of corporate taxes, but what would be your romantic ideal? Then we don't presumably renew if you had your druthers, we don't renew the corporate tax cuts or corporate taxes go up or what would you do?

Eric Zwick: So the corporate taxes are permanent. The corporate taxes rate are permanent.

Hal Weitzman: Sorry, you're talking about the individual taxes? Yep.

Eric Zwick: The individual taxes, yeah. This is also a romantic idea, but harmony between the individual and corporate rates. So, there is an issue we have currently where the top individual rate is 37%, corporate rate is 21. Maybe you have some dividend tax also on top of that. So you get up to around 30. That's a big wedge that causes people to relabel a lot of activity or reorganize. So, one aspect of the romantic ideal is to harmonize those rates, which would probably require a bit of an increase in the corporate rate to sort of get us back to, because we're not going to bring the personal rate down that far. A second component of the romantic ideal would be, yeah, to extend we're going to use the corporate system and spend money effectively through reducing tax burdens.

It would be on these marginal incentives like the accelerated depreciation research incentives, less on trying to give benefits to investments already made or extra normal returns as they like to say, or profits, excess profits through the corporate tax rate itself. So moving that corporate rate up a bit. If the international system has moved towards a minimum tax in a lot of countries or cracked down on some of the tax havens, which we've seen happen, for instance, Ireland's tax haven was closed since the 2017 reform. That creates a higher backstop for us to raise corporate taxes than where we were in 2017. So there is an interaction there-

Hal Weitzman: That's interesting. So we're not in that environment where countries trying to poach, have multinational sort of artificially say, "Yes. We, of course, we're headquartered in Country X."

Eric Zwick: Yeah, there's this dialectic thesis, antithesis going on always, and there's a back and forth always going, but we are a little bit more backstopped than we were then, I think, from the international system.

Hal Weitzman: Okay, thesis antithesis. Wow. We're going from romance to-

Eric Zwick: I don't know. We walk by-

Hal Weitzman: ... Marks and Hegel.

Eric Zwick: ... this bookstore downstairs that just inspired me.

Hal Weitzman: This is remarkable. Now listen, I mean, tax is anything that happens in Washington is very ideological, but right now we're in a real ideological moment. And tax is always ideological, I think, isn't it? I mean, I'm just wondering, you have measured this very scientifically, but that's not really what it's all about. It's really about ideology. And some people just think tax bad, government bad. Therefore, "I don't care about your calculations, really. I'm just going to lower it. And if it has a minimal effect, fine," it just puts money back into pockets of individuals, which is what I like as a anti-tax person and takes money away from the government. I mean, I think even Milton Friedman sort of talks about, "Just shrink the government and then good things will happen."

Eric Zwick: Right, right. Small enough that you could drown it in the bathtub, that's sort of the line.

Hal Weitzman: Right. So just take away their resources, take away their revenue, that's good, regardless of the effect.

Eric Zwick: Well, so we're currently doing that on the revenue side. We are not making that much progress on the spending side of that plan. So if it's a two-step plan, the second step sort of just keeps being kicked down the road. So we're running six, 7% structural deficits as a share of GDP with spending at 23, 24% of GDP and tax collections at 17, 18% of GDP. I think, yeah, that's a vision of government that does less and raises less through taxes. But we're sort of promising to continue to do the same things or even expand some of those things while cutting taxes, and that seems unsustainable. But I agree, I don't think of taxes as so ideological. I think of taxes as sort of our instrument to pay for the things we have collectively chosen to buy, and to the extent that we collectively choose to buy less or different things, then we can adjust the tax system to accommodate that. But I like to think of it as more of an instrument to solve a problem. It's a hammer.

Hal Weitzman: Absolutely. I guess, the argument I'm trying to summarize thinks of it as giving a kid money and they're going to go and buy candy.

Eric Zwick: Right. Well, yeah, they seem to be buying the candy with-

Hal Weitzman: They're money and buying candy.

Eric Zwick: ... the money [inaudible 00:25:24] future generations is the problem right now.

Hal Weitzman: Right. That's right. Yeah. The kids are smart, so they borrower money from other kids who charge a lot of interest to buy candy.

Eric Zwick: Yeah, unborn generations also. Yeah.

Hal Weitzman: Right. They're always good to do to try to-

Eric Zwick: The disenfranchise. The disenfranchise. Yeah.

Hal Weitzman: ... get them to pay for stuff. Yeah, why not? So talk a little bit, I know in your work you talk about the way the government's used the methods it has to tax businesses. There are some trade-offs, with the economy and wealth distribution. Talk about some of those trade-offs. What is the calculation?

Eric Zwick: Well, Paul Krugman has a funny line, which is that "The government is basically like a social insurance program with an army." As I said, 23, 24% GDP is mostly going towards. So, start with our social insurance programs, social security and Medicare, Medicaid healthcare, these kinds of things. If we want to pay less tax, we might need to spend less on those programs because that's where a lot of the money is. The defense is actually not that high as a share of GDP relative to our historical peaks, but it's maybe 2, 3%. We could cut that. It's not clear that we're in a Geopolitical moment where reducing our defense spending dramatically is what the doctor ordered. But maybe there's markups in our defense spending, we could shrink those by making it more competitive. And then, yeah, I mean, on the civil service, if we reduce federal employment but still want to provide the same services through contract work, it's not clear that we're actually saving any money when we do that.

And then we have interest on the debt, which is at this point a little bit larger than Medicaid, I think, or forecast to be slightly larger than Medicaid and forecast to grow dramatically. This comes from the interest rates being higher. So going back to Liz Truss example, if we're in an economic situation where there is more tightness in capital markets, borrowing a lot is going to tend to move interest rates up. And that affects the cost of borrowing, that affects the budget, that affects mortgage rates. And so, we are in a tricky situation. I think there's not a free lunch here.

Hal Weitzman: Eric, your research has been very widely cited this time around. No surprise, because heading into... As I said, the beginning, this budget battle, the tax battle this year. What response have you had from Washington folks about your research?

Eric Zwick: So there's a line I like to say, which is, "You know have good data because it reveals people's priors." So what does that mean? People on the left political persuasion are like, "Oh my God, the reform was super expensive, didn't pay for itself, didn't come even close." People on the right are like, "Look at all these growth effects. This is so great." And my view of it is like, "Well, yes, there's sort of fodder for both sides, but it's generally useful because it does guide our expectations about what would happen if we made future further changes. So we've tried to be engaged with political folks to the extent that they're interested in the evidence, and trying to help them interpret it and make sure they don't interpret it in ways that we don't think is consistent with what we're seeing.

We've talked to folks there, for sure. Evidence-based policy is not at its global max, but there are also a bunch of folks that are, I think less political, more on the technocratic side that have been super receptive and very helpful in giving us feedback. But I think also integrating some of the lessons to think about this scorekeeping, thinking about like, "Okay, this is a change proposed, here's what we think the effects will be." And recent literature seems to support the assumptions we're plugging in for making those forecasts, which are admittedly uncertain, but not anything goes uncertain.

Hal Weitzman: Okay. Eric, thank you. It's been a fascinating discussion about the romance and the Hegelian dialectic of tax cuts. Thanks so much for coming on the Chicago Booth Review.

Eric Zwick: Thanks very much. Happy Valentine's Day.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research. This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.