Larry Summers’ Qualms on Tax Reform are Misplaced

Professor Larry Summers of Harvard is doubtless one of the Left’s top economists, but he seems to be having a tough time with the tax reform effort now accelerating through Congress, his befuddlement centering on three specific issues. As he notes correctly, “most reasonable experts agree that tax reform has the potential to spur investment and raise wages while also simplifying the system and increasing its fairness and legitimacy.” Yet there remain those three issues, so for Professor Summers’ benefit and anyone sharing his concerns, we consider them in turn.

The first issue Summers raises is the tax package envisions a net $1.5 trillion tax, but he insists the economy today doesn’t need a big fiscal stimulus. He’s quite right the economy doesn’t need a stimulus today thanks in large part to the Trump administration’s regulatory relief following eight years of Obama’s regulatory assault. But Summers’ concern is misplaced. The $1.5 trillion figure only has substance in the loopy world of Washington budget mechanics. In reality, the tax reform plan now working through Congress is roughly revenue neutral and may even reduce the budget deficit in years to come.

Clearing up this particular confusion begins with the revenue baseline used by the Congressional Budget Office, which assumes about $400 billion in tax hikes that will either never happen or which, like bonus depreciation, would be subsumed in tax reform designed in part around expensing. So using a revenue baseline reflecting these realities reveals a “static” tax cut of about $1.1 billion. Further, as Professor Summers notes, tax reform can raise investment and wages, along with all other manner of income. This means more tax revenue from every tax the federal government imposes, but how much more?

Economists will debate tax reform’s growth effects until the cows come home, but a recent Tax Foundation estimate plausibly suggests GDP would be about 3.9% higher in the long run. According to analysis found in the Federal Budget’s Analytical Perspectives volume, such a result would not only eliminate tax reform’s deficit impact, but would result in a net revenue gain.

Two further points on the growth and revenue issue before turning to Professor Summer’s latter qualms. First, the revenue feedback from additional growth does not mean the tax cuts pay for themselves. The majority of the revenue gains associated with tax reform arise from broadening the tax base. The revenue feedback makes up the remaining shortfall.

Second, Professor Summers is too good an economist to fall back on the laughable argument made by some that the static deficit effect would result in such an increase in the national debt as to push up interest rates and eliminate tax reform’s growth effects. As he notes, “the national debt is already on an explosive path” left to us by President Obama having already more than doubled it. If rising national debt really had the alleged effects on interest rates, the 10-year Treasury bond would today trade at 5%, or 7%, or perhaps even more. It doesn’t. The 10-year Treasury rate has held steady between 2% and 2.5% for years, so this interest rate effect counteracting tax reform’s growth effects is just so much hot air.

Professor Summers’ second qualm is a bit subtler. He notes tax reform would allow businesses to expense their capital purchases, so “what is the case for cutting the corporate tax rate to 20 percent?” There is a solid answer to his question based on tax theory, but a simpler answer follows from an implication of his question. If there were no justification for cutting the corporate tax rate, and no particular justification for the current rate, then why not just raise the corporate tax rate to 100% as long as we’re allowing expensing? As all the “reasonable experts” he references would quickly agree, such a policy would be obviously and profoundly self-destructive. So the simple answer to Summers’ question is that tax rates still very much matter.

The third qualm giving Summers fits is a tad less coherent, referring vaguely to “new complexities” benefitting “the richest taxpayers that hurt middle class families.” The reference to middle-class families is part of a defense of some of the many complexities in the tax code that tax reform would sweep away in favor of a simpler system and a middle class tax cut. Apparently, protestations to the contrary notwithstanding, Summers is a fan of tax complexity and believes a tax cut would hurt the middle class in some manner as yet unstated.

Part of Summers third qualm involves cutting the tax rate on pass-through businesses to 25%. This is a derivative objection to cutting the corporate tax rate. Why do so? Answer: To lower the cost of capital for all forms of business and for all forms of investment to spur the increase in “investment and wages” he lauds. Again, tax rates very much matter.

Larry Summers is certainly right we have “a once in a generation debate underway.” Unfortunately, the debate is a tad one-sided as congressional Democrats have thus far chosen only to defend the current tax system with very few substantive ideas of their own for reforms to encourage economic growth. Fortunately, though much work remains, the Republicans have some very good ideas and they are making rapid progress in transforming those ideas into solid legislation.

About the authors

J.D. Foster

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.