Democrats Are Right, the Tax Bill Is a Disaster — but They're Wrong About Why

Democrats Are Right, the Tax Bill Is a Disaster — but They're Wrong About Why

© Yuri Gripas / Reuters

No, Nancy Pelosi, the recently enacted tax bill does not “raise taxes on a breathtaking 86 million middle class households.” By focusing on the distributional effects of the GOP tax plan — in an often-misleading way — Democrats have lost site of the bill’s most serious downside: its evisceration of the public purse.

Pelosi’s estimate is attributed to the Tax Policy Center’s distributional analysis of the new law. But TPC reports that middle income taxpayers (those in the third quintile of the income distribution) will receive an average tax cut of $930 per household in 2018 and $910 per household in 2025. Indeed, relatively few families stand to lose money over the next several years — and the tax increases TPC projects eight or 10 years out are unlikely to happen.

The real problem for Pelosi and her Democratic colleagues is that the rich will see bigger cuts in absolute dollar terms than those who are less affluent — an almost unavoidable feature of any across-the-board rate reduction. And this rubs equality-minded Democrats the wrong way.

Although income inequality is a traditional Democratic issue, it has really gained traction in this decade due to Occupy Wall Street’s “We Are the 99%” slogan and Thomas Piketty’s influential book, Capital in the Twenty-First Century. Democrats’ emphasis on income inequality comes at a cost: It often prevents them from supporting pro-growth policies, like this tax bill.

In the past, economists often considered policies through the prism of Pareto efficiency, the idea that a change is socially positive if it helps at least some people while harming no one. The short to intermediate impact of the tax reform comes close to meeting the Pareto standard: Most taxpayers save money and only a small number (of mostly upper middle income) families must pay more. Further, the plan can be expected to increase economic growth, albeit modestly, enlarging the total amount of wealth available for us to share.

The notion that a beneficial economic policy is bad because of its benefits are unequally distributed requires an appeal to envy and schadenfreude. Psychologically, many of us may feel worse when the wealthy get further ahead and better when they are punished. But these emotions are ultimately harmful. We’re each better off focusing on our own material and spiritual well-being rather wasting energy worrying about the other guy, or worse, using the tax system to bring him down.

It appears that Democrats are confusing the plan’s relative impact on the middle class with its absolute effect — which is generally beneficial until 2026, when most of law’s individual income tax provisions are set to sunset. By 2027, TPC expects middle quintile taxpayers to see an average $20 tax increase. 

A major reason that middle income taxpayers would face a small tax increase 10 years from now is that the measure permanently changes the way tax brackets are adjusted for inflation. Rather than using the Consumer Price Index, the new law uses the Chain-Weighted CPI. This index provides a lower estimate of annual inflation because it assumes that families make substitutions, such as buying more chicken as beef prices rise.

But the sunset has virtually no chance of occurring. Instead, Congress will face enormous pressure to extend the individual income tax cuts — much as it did when the Bush tax cuts expired. When that happened, Congress temporarily extended all the cuts, and then permanently extended lower rates for taxpayers in all but the two highest brackets.

If that happens again, the budgetary impact of the GOP tax cuts will be much greater than the headline numbers indicate. Even when economic growth is considered, the Joint Committee on Taxation estimates that the tax measure will add over $1 trillion to the debt over the next 10 years. CBO’s static analysis shows personal income tax cuts adding about $140 billion to the deficit annually between 2023 and 2025. This falls to $83 billion in 2026 as the tax cuts phase out. By 2027, the law actually lowers the deficit by $22 billion, consistent with those small tax increases forecast by TPC. A renewal of the personal income tax changes would thus add about $175 billion to the debt in 2026 and 2027. Over a 30-year period, the impact would be trillions in additional red ink.

These new shortfalls will worsen an already bleak fiscal picture. After attaining a post-recession trough of $438 billion in 2015, the deficit increased in the last two fiscal years, reaching $666 billion in the year ending September 30, 2017. Fiscal 2018 was already looking dicey, with $198 billion in red ink being added in the first two months (or $15 billion more than the same period last year). And that’s before the tax cuts kicked in. It is also before Congress inevitably puts the bulk of disaster relief spending for recent hurricanes and forest fires on the national credit card and breaks budget caps to accommodate a surge in military and non-defense spending.

By 2025, trillion-dollar plus annual deficits are likely to be the norm, so adding $150 billion annually by extending the 2017 personal tax cuts will seem to be no big deal. But at some point the cumulative impact of all this deficit spending will trigger an economic crisis.

It is in this sense that the tax cuts are not nearly as Pareto efficient as they initially appear. The tax cuts benefit most of us now by harming our future selves, our children and our grandchildren.  Congress should not have passed them without equivalent spending cuts — a virtual impossibility in today’s political environment.

If Democrats were less worried about class warfare and more concerned about the nation’s future, they could make a case against the tax cuts that would resonate with a wider swath of voters. In the Clinton era, Democrats often preached fiscal responsibility, working with Republicans to balance the budget. Now that Republicans have tossed away the mantle of fiscal rectitude, perhaps it is time for Democrats to pick it up, becoming in the process a party of the future.