Only part of tax reduction flows through to GDP growth. There are two main components to investigate—increase of spendable income to households and increases to businesses.
Purpose of Republican Tax Bill
The question that a tax bill should answer is – will tax cuts help or hurt residents of the country, not does it right wrongs in the current tax system. Why is that? The rich have become rich in the system already—through hard work, planning, system support, and luck. Since they are already prospering, why should they be the prime beneficiaries of changes to tax codes. Tax code changes should boast the entire economy by the best achievable means.
The present tax bill plans to reduce business taxes by $1000B, while individuals will see a reduction of $500B in the next ten years.
- There is the trickle-down idea of allowing business twice as much as individuals in directing their interests in spending extra dollars in their pocket, Economists have thoroughly debunked that idea.I won’t discuss it further.
- I will deal with a different question. What will be the GDP impact and its cost in the first year (2019) of the proposed tax reduction?
- A final point, that I also won’t address further in this post, is that the tax bill will grow the government debt. As Republicans long preached before their apostasy, annual deficits that grow government debt have the danger of overwhelming the economy with debt which can’t be carried. It is a folly that net worth is not considered alongside the yearly government budget, because some debt can be carried when net worth is growing.
I focus on GDP changes because that economic activity is the means that most people gain benefit from the economy. The stock and bond markets affect the 80% of individuals who are wage earners only as a muted benefit. It’s salary growth and consumer inflation are crucial to their daily life. Rising stock prices (inflation that’s not in CPI) and financial windfalls which occur on Wall Street are not tallied in GDP.
The table (Figure 1) is based on the historical spending patterns of households according to income. It’s a busy chart that requires some explanation.By columns.
- The first column divides household incomes into fifths (quintiles)
- The second shows the amount of increased income the average household will experience.
- The third shows the fractional growth the quintile will experience.
- The fourth gives the percentage of their income that a quintile household consumes.
- The poorest quintile consumes more than their income—163%. If their income is $13,000, they consume about $20,000. This is accomplished by government welfare, charities, family gifts, and underground economy.
- The fifth displays the number of households in the quintile, in thousands. The lowest quintile has 25,061,000 households in it.
- Next, in the sixth column is the aggregate amount of tax reduction for the quintile. From $1 billion for the poorest to $127 billion to the richest.
- In the seven column is the reasonable immediate impact on GDP determined by calculating that each quintile will consume the same chunk of their tax reduction as they currently consume.
- The final column shows the amount of excess income due to tax reduction that the quintile will be saving or investing.
Bottom Line on Household Reductions
The bottom line is that $129B will be added to GDP from the $194B in increased take-home pay for all householders. Not bad, about 0.7% of our $18.6T GDP. Two-thirds of the individual tax reduction grows GDP and overall health of the economy. The non-consumption income feed into financial institutions will result mainly in inflation of asset values.
I’d be remiss if I didn’t mention that nearly $200B of the total $500B individual tax reduction occurs in the first year. The tax savings for household must go down dramatically as the years go on.
A big part of the hype about the tax plan is that businesses will use their tax reductions to invest in their businesses and new ventures. I don’t know of anyone who wishes that to be false, but is that wish reasonable?
Business investment contributes about 16% of GDP. Most of that is in support of ongoing business activities. Research and Development (R&D), the manner in which next business opportunities arrive, is estimated to be 2.79% of US GDP.
Before discussing corporations, let’s discuss small businesses and pass-through entities.
- 90% of small businesses pay less than 25% tax rate. They will see no benefit from the business tax rate being cut to 25%.
- 10% of small businesses which pay above 25% tax rate will be the only small businesses that benefit from the tax cut. They already earn 50% of all small business profits.
- The tax rate change will benefit the small businesses that already are flourishing. They will be given an addition financial benefit to beat their small business rivals with.
When they see larger numbers on their after-tax profit, corporations have shown the actions they take.
- Stock buybacks. Inflating the share price and increasing the earning per share, so company executives get bonuses and large shareholders hold stock of increased value.
- Dividends.Paying money to stockholders. In 2016, 40.2% of all S&P 500 corporate income was paid out as dividends.
- Yardeni, Research, Inc. calculate that S&P 500 companies paid out 91% of their operating income as buyback and dividends in the 2nd quarter 2017.
- Perhaps there will be a tiny increase in Research & Development out of the remaining 9% of their tax reduction.
Additional household spendable income will increase the GDP by 0.7%. The corporate tax change will put upward pressure on stock and asset prices. It will also increase financial maneuvers which are not new business investment.