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Economist Warns of Dire Consequences if Tax Reform Stalls

Posted on September 1, 2017 by Jonathan Curry

Failure by this Congress to pass comprehensive tax reform wouldn’t just be a missed opportunity for economic growth — it could also have painful consequences for the U.S. economy, the U.S. Chamber of Commerce’s top economist said August 31.

“If we don’t have tax reform sometime this year or early next year, a lot of business investment that’s been predicated on getting tax reform done will have been poorly made,” J.D. Foster said at a briefing hosted by the Chamber. “Business investment will likely contract significantly, and we will have a significant period of weakness, in my opinion.”

“How weak, we don’t know,” he continued. “But that’s not a risk we want to run.”

Foster later told Tax Analysts that a recession wouldn't be out of the question. “Business investment can shift very quickly. They just go in and say, ‘No, I don’t need that,’ and cancel orders.” 

But the more serious concern, according to Foster, is if the international tax system will remain unchanged. The recent slowdown in corporate inversions and foreign takeovers of U.S. companies is partly a result of President Obama’s anti-inversion regulations, though he said companies would quickly find ways around those. But he also attributed the slowdown to companies anticipating lower rates and changes in how the U.S. taxes foreign-source corporate income.

“If we leave this system in place, you will basically put a ‘For Sale’ sign on every U.S. multinational corporation,” Foster said. “They’re going to have self-help territoriality, and if you wonder what that means to U.S. communities, go to St. Louis where Budweiser used to be.”

“This is the big shot,” Foster said. If lawmakers can’t manage to pass a pro-growth tax reform package now, while Republicans have majorities in Congress and control the White House, then the prospects of it happening anytime in the near future are low, he explained. Businesses both in the United States and abroad “are going to think very differently about the U.S. economy” if the existing tax code stays in place, according to Foster. “That translates into a reduction in business investment in this country.”

Economists Review

Several economists contacted by Tax Analysts weighed in on the prospect of an economic downturn if tax reform goes the way of healthcare reform, with mixed assessments regarding Foster’s predictions.

Kyle Pomerleau of the Tax Foundation said Foster’s theory of an economic contraction is “defensible,” although he was more cautious in drawing conclusions about the magnitude of any slowdown.

“It is conceivable that companies have made new investments assuming that tax rates are going to be lower in the future. If reform doesn’t happen, those investments may no longer be profitable as companies had predicted, resulting in some sort of contraction,” Pomerleau said.

Alex Brill of the American Enterprise Institute offered a more mixed review of Foster’s predictions, and he emphasized that Congress’s tax reform timeline should not be dictated by attempts to “micromanage the quarter-by-quarter performance of the U.S. economy.”

Still, Brill acknowledged that it’s politically important to prioritize and maintain momentum on tax reform. “Moving slowly raises the risk that the process will never conclude,” he said. “A protracted process faces higher risks of political interference, and there are always competing legislative matters that can interfere and further delay a slow-moving reform agenda item.”

Unlike Foster, Brill said he did not foresee what he called an “economic cliff” if tax reform stalls. Rather, he said the consequence of failure would be more of the same: “More U.S. firms will be acquired by foreign firms, more investment will be made abroad instead of domestically, more stagnant wage growth, and more misallocation of capital.”

Economists on the progressive side, however, dismissed Foster’s predictions altogether.

Diane Lim, principal economist of the Conference Board and a member of the National Association for Business Economics (NABE), cited the results of an August NABE survey as evidence that Foster’s concerns are overblown. That survey found that NABE members believed there was only a 10 percent probability of tax reform legislation passing this year, and a 15 percent probability of it passing in 2018.

“The business community already puts very low probability on meaningful tax reform happening this year, or even next, so how could its failure to pass cause a contraction in investment?” Lim asked. Expectations for the passage of business-friendly tax reform legislation have already declined relative to the start of the Trump administration, so “those pessimistic expectations are already built into current business decisions,” Lim argued.

Matthew Gardner of the Institute on Taxation and Economic Policy likewise said Foster’s claim of an economic contraction if tax reform falls through “doesn’t seem especially credible. . . . In fact, I could see the opposite argument.” President Trump consistently calls for a 15 percent corporate tax rate, but despite claims about closing special interest deductions, “no one has shown how you can cut the corporate rate to 15 percent without blowing a hole in the deficit,” he said.

In that scenario, “I think you can make a pretty good case that, far from strengthening the economy, the sort of tax changes Trump has promised would actually endanger our economy over the long haul,” Gardner said, explaining that higher deficits would threaten the U.S. capacity to maintain infrastructure that businesses rely on, or to pay for healthcare.

Lim echoed Gardner’s concerns about higher deficits, saying that “countless objective analyses,” including those by the Congressional Budget Office, have found that, in most cases, revenue-losing tax reform “can be counterproductive to the economy.” An exception would be if the U.S. were in a recession, when deficit-increasing tax cuts could help stimulate demand where demand falls short of supply. But, she noted, the U.S. is already at “full capacity” and near full employment, so a tax cut would only expand the supply side of the economy.

Gardner also contended that the major problem with corporate taxation isn’t that companies are physically relocating factories or workers offshore or not investing in the U.S.; rather, he said, “they’re putting their intangible assets in places where they can pretend they’re earning a bunch of money on a beach in the Cayman Islands.”

Like Brill, Gardner said that if tax reform fails, companies will continue to shift profits out of the U.S.; but he argued that nothing Trump has proposed would do anything to stop that. “In fact, we need to do virtually the opposite of what Trump has proposed in order to solve this problem,” he said. Gardner recommended ending the system of deferral and rewriting corporate tax rules to prevent companies from engaging in “sham transactions.”

And while Garder acknowledged that the stock market has fluctuated in response to Trump’s statements on tax reform, “it’s hard to believe that major corporations are going to change their investment behavior . . . based on what happens with the tax system.”

Businesses make investment decisions based on demand for their products, not changes in the corporate rate, Gardner said. Many companies in the U.S. are already “currently sitting on huge piles of cash,” but the reason they’re not hiring more workers or investing in new productive capacity isn’t because of the tax system, it’s because they don’t see the demand. “There’s nothing that President Trump and Congress can do to the tax system that’s gonna change that calculus,” Gardner said.

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