Election Countdown: Taxation

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Laffer curves and campaigns

Unlike the current election, certain presidential candidates of the past featured tax policy as a cornerstone of their campaign. Most notably, President Ronald Reagan proposed a supply side economics platform in 1980 that included lower taxes on the wealthy. He invoked the Laffer curve, a theory that increasing tax rates beyond a certain point is counter-productive for raising further tax revenue, while lowering taxes will result in more income and more tax revenue.

Fast forward a few elections and Steve Forbes, in his quixotic bid for the Republican nomination for President in 1996 and again in 2000, made the case for a flat tax on individuals. He wanted to overhaul the US tax code and dramatically simplify it. Also during the 2000 election, President George W. Bush made a reduction in taxes an important part of his platform; his significant tax cut on dividend income is an important legacy of his administration.

Trump's tax plan

In recent years taxes have become a lightning rod for many voters. The Tea Party has emerged as a powerful force in the past decade, demanding fiscal conservatism and lower taxes. In this environment, Donald Trump has proposed a fairly traditional Republican platform on taxation: in general he plans to simplify and lower taxes. In terms of income taxes for all households: he would like to move from seven personal income tax brackets down to three and streamline deductions to simplify the tax code; he would also repeal the estate tax.

In terms of the corporate tax rate, Trump proposes to reduce it from 35% to 15%, which would be a dramatic decrease. Trump also proposes a one-time repatriation tax of 10% on corporate profits held overseas. Trump's corporate tax platform would significantly improve the tax competitiveness of the US relative to other countries. However, his tax cuts would cause a substantial drop in tax revenue; the Tax Foundation estimates that Trump's tax proposals will result in a net decrease in revenue to the US government of $23.9 trillion over 10 years. This is of concern because it would dramatically increase the national debt over time.

Clinton's tax plan

In terms of Hillary Clinton's tax platform, it is a traditional Democratic one. Most of her policies would disproportionately impact high earners by increasing taxes on high income individuals and estates, and also by limiting deductions. She would also dis-incentivize short-term holdings of securities by changing the requirement to qualify for the lower long-term capital gains rate to a holding period of six years; investments held for a shorter period of time would be taxed at a higher capital gains rate.

In terms of corporate tax policies, Clinton has a 'carrot and stick' approach, which would incentivize what is perceived to be responsible corporate behavior and penalize that which is not. For example, her proposals would discourage activities in the financial markets that are "non-productive," such as high-frequency trading and dis-incentivize tax inversion mergers through the use of an "exit tax."

Clinton would also offer tax credits for businesses that share profits with employees and hire apprentices. She would also eliminate tax benefits currently in existence for traditional energy and instead provide those benefits to clean energy. In total, the Tax Foundation estimates that Clinton's tax proposals will result in a net increase in revenue to the US government of $1.1 trillion over 10 years.

Taxes and the multiplier effect

But arguably more important than the tax revenue each candidate's policies would generate is the impact such policies could have on the economy. We can again turn to estimated multiplier effects provided by the Congressional Budget Office (CBO) for a sense of how impactful they could be. Similarly, the multiplier effect can also vary by type of tax policy.

That's because, like monetary policy, tax cuts have an indirect impact on the economy and employment because they are dependent upon market participant psychology. In other words, individuals may or may not spend the savings they receive from tax cuts.

In the case of the Great Recession in the US, some of the tax cuts' effectiveness is believed to have been limited because they were used for the purposes of deleveraging rather than spending. In addition, the efficacy of tax cuts depends on who receives the benefits. Typically when lower-income individuals receive tax cuts, there's a greater likelihood that money is spent rather than saved. This is borne out in statistics from the CBO. For example, the CBO estimates that one-year tax cuts for higher-income people have a multiplier effect as high as 0.6, while two-year tax cuts for lower- and middle-income people have a multiplier effect as high as 1.5.

Which policy is better for the economy?

In terms of individual tax policies, Clinton's proposal would likely be more stimulative for the economy given that the tax cuts would go to lower income individuals who are more likely to spend them rather than save them. However one positive aspect of Trump's individual tax policy proposals is that the tax code would be somewhat simplified, which addresses a longstanding criticism of it. With regard to corporate tax policy, Trump's plan would be more stimulative; dramatically cutting the corporate tax rate would be an important move in making the US more competitive and business-friendly, attracting and retaining companies that can then employ workers.

Many caveats go along with the CBO's multiplier effect research. It is important to note that different economic environments and different monetary policies will likely result in different multipliers for the same fiscal policy. We also need to contemplate the type of budget deficit these policies would create.

One more caveat: any tax proposal needs to be passed by Congress to have any impact at all; so we need to factor into our calculus our expectations for the composition of Congress. All in all, a close examination of the candidates' tax policy platforms is critical, given the important role fiscal policy will have going forward as the Fed normalizes monetary policy.