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Trump’s Tax Plan Missing Pro-Growth Tax Reform

Territorial tax system would benefit US exporters with more shipments of export cargo and import cargo in international trade.

Trump’s Tax Plan Missing Pro-Growth Tax Reform

Last week the Trump administration released the outlines of the president’s proposal for tax reform. While some of the provisions are critical for boosting US economic growth, like a lower corporate tax rate and a so-called “territorial” system for taxing companies’ foreign profits, the plan is silent on many other key measures that are necessary to boost productivity and competitiveness.

Critically, the plan also would add trillions of dollars to the deficit over the next decade, an issue the administration further aggravates by proposing to cut taxes on so-called “pass-through” businesses. The unfortunate effect of these flaws will be to divert attention away from other proposals that have a greater chance of passing Congress, which will slow progress toward much-needed tax reform to boost the U.S. economy.

Earlier this year, the Information Technology and Innovation Foundation issued a report spelling out five key provisions that any tax reform should include. The Trump plan has a mixed record on these. The plan does lower the corporate rate to 15 percent. It also moves the United States to a territorial system in which companies pay U.S. tax only on their domestic profits. This will immediately make the United States more attractive as a place to do business. Companies based in America would face the same marginal tax rates as their competitors when they sell in overseas markets. Perhaps even more important, a lower rate will reverse the incentives to move profits abroad through so-called “inversions” or transfer-pricing agreements. The proposal also contains a one-time tax on past earnings that have been parked abroad. This will produce hundreds of billions in tax revenue and remove any incentive to keep the money overseas in the future.

Unfortunately, the proposal contains no realistic method of paying for at least some of the lower rates. Indeed, it aggravates the problem by extending tax cuts to individuals, especially on their business income. Pass-through entities would not only continue to enjoy a much lower total tax rate than regular corporations, but their owners also would pay much lower taxes than their employees. As ITIF has argued previously, any attempt to deal with growing financial deficits will require higher taxes on individuals. Cutting pass-through rates, which would mainly benefit the well-off, is the opposite of what is needed.

The Trump plan also is silent on some of the other key components of reform that would boost US productivity and competitiveness. There is no mention of the research and development tax credit, which needs to be expanded to spur more innovations that benefit the whole economy. Nor is there any mention of an “innovation box” that would give companies a lower tax rate on profits derived from intellectual property, another way to incentivize research. Finally, the plan is silent on whether it would allow companies to depreciate capital expenditures at a faster rate, which would encourage them to invest in their own productivity.

A plan supported by House Speaker Paul Ryan would allow firms to write off the full cost of their investments in new software, machinery, and equipment. At a minimum, any reform should make current provisions for bonus depreciation permanent and allow all firms to write off the first $500,000 in qualified investments. These three provisions are critical not just because they would directly spur more innovation and investment, but also because they would help firms in globally traded industries succeed in the face of intense competition.

There are two reasons for an administration to issue its own proposal. The first is to set forth a clear vision for reform that is compelling enough to attract the support of others. The second is to identify a compromise that can attract enough supporters to pass. For either strategy to succeed, people have to believe that the administration is fully committed to the ideas it is putting forth. This plan does not meet either test. It is a step backward because it diverts attention away from the House bill, which continues to have the best chance of passing in a modified form, and therefore moving the debate to the Senate.

Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation.

Trump buddget hurts US exporters of shipments of export cargo and import cargo in international trade.

First Look at Trump Budget Isn’t Pretty

The Trump administration released the first document of its proposed budget for the 2018 fiscal year last week. The document only covers discretionary programs (those with funding that regularly runs out unless Congress votes to give them new money). Still to come are proposals for mandatory spending, which makes up roughly 70 percent of all spending, and proposals for all of the revenue sources. But the preliminary evidence suggests that the administration is taking its cues from a deeply flawed framework put forward by the Heritage Foundation. It is proposing to slash federal investments in critical areas that contribute significantly to economic growth.

The immediate takeaway is that the Trump administration is advocating a huge increase in defense spending, which it proposes to pay for with large cuts to almost all other federal departments. In doing this, the budget would significantly shift spending away from public investment in education, research, and infrastructure, among other areas. This matters because these kinds of investments are essential for faster economic growth, and without that, living standards will stagnate.

The reality is that if the United States is going to successfully manage its growing financial problems and improve living standards for all Americans, it needs to increase its investment in the primary drivers of innovation, productivity, and competitiveness. The Trump budget goes in the opposite direction. If these cuts were to be enacted, they would signal the end of the American century as a global innovation leader. America’s lead in science and technology was built on the fact that in the 1960s the US government alone invested more in R&D than the rest of the world combined, business and government. The Trump budget throws this great legacy away and puts the country on a path to being an economy that is a “hewer of wood and drawer of water.”

Although the budget does not contain enough detail to see what would happen to every individual program, such as the Defense Advanced Research Projects Agency (DARPA), it does mention many that are important for innovation, productivity, and competitiveness. For example, it would eliminate funding for the Overseas Private Investment Corporation and the US Trade and Development Agency, both of which help US exporters compete in foreign markets. Also gone are the Manufacturing Extension Partnership (MEP) program, which helps disseminate technology and management improvements to small- and medium-sized manufacturing companies. In education, the president would eliminate more than 20 programs, including the Teacher Quality Partnership and Impact Aid Support Payments for Federal Property, dumping more of the burden of improving education onto states and localities.

In research, the administration proposes to eliminate ARPA-E, just as new energy technologies are becoming competitive with traditional sources, on the specious premise that “the private sector is better positioned to finance disruptive energy research and development and to commercialize innovative technologies.” The Department of Energy’s Office of Science would lose $900 million, or nearly 20 percent of its funding. The budget cuts funding for the National Institutes of Health, perhaps the world’s premiere medical research facilities, by over 18 percent. This accompanies cuts of 40 percent in the science programs at the Environmental Protection Agency and 26 percent for the research arm at the National Oceanic and Atmospheric Administration. Although the budget does not mention the National Science Foundation, cuts there also seem probable. Since these agencies fund a great deal of research in universities, cuts to them may prematurely end many careers among the next generation of research scientists.

The federal government does a lot of things that contribute to economic growth. Key among these are funding education, supporting research, and building infrastructure. Although some of this is also done at the state and local levels and in the private sector, federal involvement often plays a big role in encouraging additional spending from other sources. In the absence of contrary evidence, there is no reason to think that a reduction in federal funding will be made up by higher spending somewhere else. Indeed, withdrawing the federal government from some of its core responsibilities may cause others to also cut back their investment because they anticipate slower growth and fewer opportunities going forward. Any spending cuts will slow economic growth in the short-run. However, cuts in the government’s efforts to boost innovation and investment have a more lasting effect because they also eliminate the contributions to higher growth that are the result of this spending.

Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation.