Impact of Tax Reforms on United States Economic Growth

Impact of Tax Reforms on United States Economic Growth Name Institutional affiliation Table of Contents TOC \o "1-3" \h \z \u 1.0 Introduction PAGEREF _Toc7430046 \h 22.0 Effects of Tax on the Economy PAGEREF _Toc7430047 \h 22.1Tax Cut Rates PAGEREF _Toc7430048 \h 42.2 Taxation System PAGEREF _Toc7430049 \h 52.3 Financing PAGEREF _Toc7430050 \h 52.4 Government Entities PAGEREF _Toc7430051 \h 53.0 Historical Analysis: Taxes and U.S. Economy PAGEREF _Toc7430052 \h 64.0 Conclusion PAGEREF _Toc7430053 \h 7References PAGEREF _Toc7430054 \h 8 Impact of Tax Reforms on United States Economic Growth 1.0 Introduction Towards the end of 2017, the United States enacted the US tax reforms that contained elements that aimed at promoting a stronger economic growth in the country. These elements included individual tax cuts, a shift towards a territorial global taxation system with anti-base erosion measures, a globally competitive corporate tax rate, and a unlocking overseas cash with compulsory ‘deemed repatriation’ of unrepatriated proceeds. According to PwC, the 2017 legislation provided a net tax cut of $1.5 trillion over the budget period between 2018 and 2027. In recent times, a general bipartisan agreement established that the US corporate tax rate required to be decreased to a more competitive level based on other leading economies in the world. Although Democrats have harshly opposed any reduction in corporate tax rates, the chairman of the House Ways and Means Committee has always expressed support for the reduction of corporate tax rates arguing that it would be fiscally responsible. Prior to the 2017 tax act Wyden, a Senate Finance Ranking Member introduced comprehensive tax reform legislation, which would have lowered the rates of corporate income tax to 24% regardless of the current taxation of a United States firm’s global income, which is devoid of benefit of deferral. Overall, these legislations are geared towards enabling conditions for the growth of the country’s economy and that of its citizens. However, while reforms aimed at reducing the existing subsidies, improving incentives, avoiding deficit financing, and avoiding windfall gains will have positive effects on the long-term economic growth, they may also create some trade-offs between efficiency and equity. This paper discusses the impacts of income tax reforms on tax cut rates, taxation system, financing, and government entities, and relates how these changes affect economic growth and business investments within the United States and internationally.[PwC (2019). Moving beyond tax reforms. Retrieved April 29, 2019, from: /us/en/tax-services/publications/assets/2019-tax-policy-outlook-moving-beyond-tax-reform.pdf] [Gale, W.G., & Samwick, A.A. (2014). Effects of income tax changes on economic growth. Economic Studies at Brookings. Retrieved April 29, 2019, from: /wp-content/uploads/2016/06/09_Effects_Income_Tax_Changes_Economic_Growth_Gale_Samwick.pdf] 2.0 Effects of Tax on the Economy Economists and policy makers have long been interested in understanding how the potential changes to the system of personal income tax can affect the overall country’s economy. In December 2017, the United States through Congress enacted one of the most sweeping tax changes in the history of the country. These changes saw a reduction of statutory tax rates for both businesses and individuals and altered the tax-base aimed at removing distortionary tax preferences and creating new ones in other cases. This law sparked heated debates on many issues, including its long-term impression on the capital-labor ratio, real wages, GDP per employee, and overall economic growth. Experts are divided on the opinion that the corporate tax component of the tax reform would result in positive long-term effects in all the domains with some economists remaining to be consistent critics of the law. Barro and Furman apply a simple neoclassical model of the economy to draw useful insights in assessing the macroeconomic impacts of tax changes. However, the authors share differing views on the question of the effects of tax bill on the country’s economic growth based on three dimensions. These dissimilarities include the different expectations for future spending and tax policy, differing views on whether and t which magnitude higher budget deficits can result in crowding out, and while experts agree on the incompleteness of the existing model that fails to capture economically critical aspects of the law, they disagree on the direction that will drive the estimates. Regardless of the positions of economic experts and policy makers, the 2017 tax reforms will have major impacts on the country and its citizens.[Barro, R.J., & Furman, J. (2018). The macroeconomic effects of the 2017 tax reform. Brookings Papers on Economic Activity: BPEA Conference Drafts, March 8-9, 2018. Retrieved April 29, 2019, from: /wp-content/uploads/2018/03/4_barroSamwick.pdf] [Barro & Furman (2018)] [Ibid] Reforms with a component of income tax change will ultimately have an impact on economic growth. Gale and Samwick have examined how the changes to personal income tax can affect economic growth in the long-term. In their article, the authors argue that the financing and structure of tax changes are critical to the achievement of economic growth. However, while tax cuts may motivate people to work, invest, they may result in an increased federal budget deficit, which will also reduce the national savings and increase interest rates if not financed by immediate spending cuts. The observation is that the net growth impact might be uncertain, but evidence points that the impact is either negative or negligible. To counter the impact of tax cuts rates on budget deficits, economists prescribe that base-broadening measures can be invaluable. However, at the same time, it should be noted that base-broadening measures could also reduce the impact of saving labor supply, and overall investment, which will result in a reduction in direct growth impact. Such measures also tend to reallocate resources across industries towards their highest-value economic utilization thus leading to increased efficiency and growing the overall size of the economy. Conclusions from Gale and Samwick study indicate that not all changes in tax system will have equal impacts on economic growth. In their observation, the authors argue that tax reforms that reduce existing subsidies, improve incentives, avoid deficit financing, and avoid windfall gains will tend to have more auspicious effects on economic growth in the long-term but may also lead to trade-offs between efficiency and equity. In the article, Gale and Samwick (2014) focus on two categories of tax reforms: income tax reforms and reductions in personal income tax rates. Income tax reforms are changes broadening the income tax base while reducing statutory income tax rates. However, such tax changes will maintain the levels of overall revenues and the distribution of tax burdens resulting from the current income system.[Gale & Samwick (2014)] [Ibid] [Gale & Samwick (2014)] There are potential impacts of income tax reforms on Gross Domestic Product (GDP) and expansion of the supply sector of the economy. Such expansions could take the form of an increased annual growth rate, a single increase in the size of an economy, which does not affect the future economic growth but rather positions the economy on a higher chance of growing, or both. The focus on the expansion of the supply sector of the economy and the long-term impact is contrary to the short-term effects, which is also known as “economic growth” where a boost in demand in a slack economy can increase the GDP and facilitate the alignment of actual with potential GDP. In general, income tax is central to revenue generation and is recognized to have far-reaching impacts on the after-tax income distribution and effects on a wide range of economic activities. Gale and Samwick find that although there is little doubt that tax reforms can influence the economic choices of a country tax cut rates will eventually result in a larger economic growth. While tax cuts will increase the after-tax returns to working, investing, and saving, they will also cause an increase in the after-tax income that people receive from their present levels of activities, which reduces their need to work, invest, and save. The first impact usually raises the economic activity via what is referred to as “substitution effects” while the second impact reduces the income effects. In case tax cuts are not financed through spending cuts, tax cut rates will result in an increase in government borrowing which will consequently reduce long-term growth. Both simulation analysis and historical data is consistent with the concept that tax cuts if not immediately financed through spending cuts, they will result in little positive economic impact. Similarly financing tax rate cuts by immediate cuts in unproductive spending will increase output. For the purpose of this paper, the impacts of changes in tax system on tax cuts rates, tax reforms, financing, and other government entities will be reviewed.[Fieldhouse, A. (2013). A review of the economic research on the effects of raising ordinary income tax rates. Economic Policy Institute. Retrieved April 29, 2019, from: /publication/raising-income-taxes/] 1 Tax Cut Rates Reducing income tax rates will influence the behaviors of businesses and individuals through income and substitution effects. The positive impacts of tax cuts on economic growth is likely to be experienced due to lower tax rates that increase the after-tax rewards to working, investing, and saving. These rewards will induce more efforts in working, investing, and saving among businesses and workers through substitution and this is the intended effect of tax rate cuts on economic growth. Another typical positive effect of pure tax rate cuts is that they tend to reduce the value of present tax distortions while inducing an efficiency-improving shift in the economic activity composition away from the presently tax-favored industries such as housing and healthcare. However, pure tax rate cuts may also be an avenue for positive in...