What the GOP Tax Bill Means for Libertarians

"It's basically reassembling deck chairs on a really messy and horribly complex system": Q&A with Chris Edwards, CATO's Director of Tax Policy

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With Republican tax reform almost a sure thing, the nation is poised to experience the most sweeping and significant changes to the tax code since the late 1980s. But are those changes—including lower corporate and individual rates, reductions in some longstanding deductions, and almost certainly trillions of dollars in new national debt—good from a libertarian perspective.

Chris Edwards, director of tax policy at the CATO Institute, likes most of what he sees on the corporate side of reform. But when it comes to individual tax policy, he tells Reason's Nick Gillespie, "It's basically reassembling deck chairs on a really messy and horribly complex system."

Edited by Ian Keyser. Cameras by Meredith Bragg and Mark McDaniel. Music by _ghost, lisenced under Creative Commons CC BY 3.0 US.

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This is a rush transcript. Check all quotes against the audio for accuracy.

Nick Gillespie: Hi, this is Nick Gillespie for Reason. Today we're talking with Chris Edwards. He's the Director of Tax Policy at the Cato Institute and we're talking about Republican tax reform and the implications for the economy and what it means for libertarians. Chris, thanks for talking to us.

Chris Edwards: Thanks a lot for having me, Nick.

Gillespie: Give us your general score card. Is this good? Is it bad? Is it somewhere in between?

Edwards: The main driver here is the corporate tax reforms. The United States has the highest corporate tax rate in the world. The Republicans would slash the corporate tax rate down pretty dramatically down to 20% at the federal level.

Gillespie: And that's from 35%?

Edwards: From 35 down to 20%. That sounds pretty low, but actually the global average rate is only 24% today. If you think about the United States, we've got our federal rate, but we've got state corporate taxes on top up to about 10% or more. Even with the Republican cuts, we'd only just barely start getting competitive globally. That's the corporate stuff.

Gillespie: Before we get to the individual side, with the corporate stuff, one of the things that opponents of tax reform say is, 'So, corporations make a huge amount of money. They're solelists literally and figuratively.' Why are we cutting taxes on corporations and what is the thinking behind that? Why is that a good thing?

Edwards: You'll hear critics say, 'American corporations are usually profitable today. A lot of them are sitting on a big pile of cash. Why do they need tax cuts?' The reason is because corporations are forward looking. They think about building a new factory here versus in Mexico or China, and they look at that stream of future profits and they look at how much the government tax grab on that will be. They might be sitting on cash now, but the reason they're not investing it is because the U.S. corporate tax rate is so high. You cut the corporate tax rate, corporations at the margin, there would be more factories, more hiring will make more sense in the United States versus our competitors. They will invest more in the long run, and they'll build more factories. You build more factories, you got to hire more workers, the demand for U.S. workers will go up and then wages will rise.

Gillespie: This sounds like Trump's, but this is Trump's nightmare, because then suddenly people from Mexico are going to start coming back to the United States instead of leaving, which is what's happening.

Edwards: You know the demand for labor will go up a lot. The reality, Nick, is that even though the U.S. unemployment rate is pretty low now, our participation rate in the labor force has been falling, especially for middle-aged men for a number of decades now. We want to get a lot of those folks off the sidelines back in the workforce. I think the corporate tax cut really goes to that issue.

Gillespie: There's also a shift, and I guess this affects both the corporate as well as the individual rates. The U.S. currently taxes on a global basis. Both plans would shift into a territorial basis. What's the difference and why is that important?

Edwards: Right now, U.S. corporations, you think about a big corporation like General Motors or DuPont or Intel, they have subsidiaries in dozens and dozens of countries around the world. The United States today says, 'We're going to tax you on your global operations.' Think about this. DuPont, let's say they have a subsidiary in Brazil making some chemical product to supply the Brazilian market. The U.S. government taxes those profits right now. But you think about a German chemical company with a subsidiary in Brazil serving the Brazilian market, the German government at home doesn't really care what the subsidiary does, and so it's more competitive than the U.S. subsidiary. How does that affect us? We want our foreign subsidiaries to be competitive because they expand their sales and global markets. The profits pour back into the United States and that tends to suck exports out of the United States.

When our corporations do well abroad, they take a lot of imported, intermediate goods from their U.S. production. We want our multinationals to do well, it means they'll invest here, more global headquarters of companies will locate here, and their foreign subsidiaries will do well, which is good for our workers in our economy. As you know, there's been this drain over the last few decades on multinationals moving their headquarters out of the United States, because it's a punishing place to locate the headquarters of multinationals. Republicans moved to what's called a territorial system, so that'll draw multinational headquarters back to the United States.

Gillespie: The corporate side, or the business side of this seems pretty good, and from a libertarian, from a free market angle, there's not that much to complain about other than rates could always be lower. The individual side is more of a shit show, right?

Edwards: Absolutely. It's basically reassembling deck chairs on a really messy and horribly complex system. There is a little bit of simplification. Republicans double the standard deduction, so that means more people will be taking the standard deduction, less people taking itemized deductions like the mortgage interest deduction. That's good. It's a bit of a simplification. There's a little bit of rate cut in. I think that the joint committee on taxation, the official scoring body, found that there would be a better average of about a two percent marginal rate cut on the individual side, sort of on average. That's good, but there will be a lot of new complexity, Republicans will cut the tax rate on so-called pass-through or small businesses a little bit, but the rules will be very complicated. If you're a law firm, you don't get the rate cut, but if you're a small manufacturing firm, you do get the rate cut, there will be a lot of lobbying and fighting over those sorts of breaks.

Gillespie: Why is it good to get people out of itemizing deductions? You said by increasing a standard deduction. Why is itemization bad?

Edwards: I think it treats people unfairly. Right now, renters don't get the special break from the government, but homeowners do get the special break from the government. It's the same as other itemized deductions. Why should the government be playing favorites, giving special breaks for some Americans and not others? I think we ought to have low rates and equal treatment across the board. You pay a certain flat percentage on what you earn, although, I would have a large deduction at the bottom, because there's no point taxing people who are below the poverty level, because they get the government benefits anyways, so have a big giant exemption and then tax everyone a flat rate across the board equally.

Gillespie: We're in a situation where there might even be a majority of Americans living in households that pay no federal income tax. On a certain level, that seems great. You're poor, you shouldn't be paying it. When you're talking about half of the population, why does it present a problem to take everybody off the tax rolls?

Edwards: One of the reasons why you want to go to a flat tax where everyone pays an equal amount is then everyone feels the pain of big government. Taxes are price of government, you want people to feel the price, and so that if they feel the full price of government it limits the demand for big government. That's a good thing. You're right. About 45% of U.S. households now pay absolutely no federal income tax unfortunately. The tax code is extremely progressive, to use the liberal word for that. I use the word graduated, meaning people at the top pay this huge bulk of taxes. As you know, some of these numbers, the top one percent of highest earners pay 40% of all federal income taxes. It's really incredible, and that to share the burden paid by the top group has gone up and up and up, which means that the share paid by everyone else, by most voters has gone down, so they're demanding more government. That's not a good thing.

Here's a startling statistic. The United States has the most progressive or graduated income tax code of all the OECD industrial countries. The most progressive of all. It's remarkable, and this is America.

Gillespie: That means that it goes from relatively poor people pay little or no taxes and the wealthier you are, the more highly taxes you are.

Edwards: Don't believe the newspaper headlines that are saying, 'The rich are going to make out like bandits with this tax legislation.' Not true at all. This is going to make the tax code more progressive, which is not a good thing from my point of view.

Gillespie: The other thing is that the overall level of revenue that's generated … For most of 21st century, we've been pulling in government revenue from all sources, about 70% of GDP, right around there. There were some declines during the recession and whatnot. Will this tax reform increase that amount, and if it does, is that a good thing from a libertarian market point of view? Do we want the government to be actually taking more income out of our pockets?

Edwards: The Republicans have set aside a trillion and a half dollars over 10 years for this tax cut, and that's scored in static basis. Some of the business reforms will increase. GDP will move the economy upwards, so that'll cause a reflow of revenue to the government. However, it's still going to be a revenue loser for the government. This will be a net tax cut overall. The reason is, as we were just discussing, a lot of the individual tax changes don't do anything for economic growth, so they're just a pure revenue loss to the government. Those sorts of tax cuts, I could take it or leave it. If you believe in starve the beast, then yeah, let people keep more of their money. For me, I think if we're going to cut taxes, we ought to cut taxes in a way that makes the overall economy grow more strongly.

Gillespie: Let's talk a little bit about starve the beast, which is the idea that if you reduce the amount of money that government can raise it will spend less. That pretty clearly is a wrong theory because we've been borrowing and borrowing more and more money, and nobody did that more than George W. Bush, and Barack Obama followed in his footsteps of putting more and more on a national credit card. Is there any connection, because this is what Republican proponents of tax reform say, 'We're going to get the government, we're going to drop taxes and the drag in the economy, and then we're going to get spend in cuts.' Is there any reason to believe that, or what are the steps that lead from tax reform to spending cuts down the road?

Edwards: Let me start at the state government level. State governments are required to balance their budgets every year. Starve the beast does probably work, because a governor cuts taxes, then it really forces the legislature down the road to cut the spending. U.S. federal government, of course, can spend as much as it wants, so starve the beast doesn't seem to work anymore. I think a few decades back, starve the beast did work because politicians were scared of big deficits. You saw during the '80s, Reagan cuts taxes and then there was a big movement with various budget reform plans to try to restrain spending. That is no longer the case, and the reason is because we have global capital markets. The U.S. government can borrow as much as it wants and it doesn't push up interest rates. It doesn't push up people mortgage rates. It doesn't cause any pain for politicians.

Gillespie: Why should we worry about deficits? This is something, when Republicans are in power and they're running up deficits, Democrats are like, 'We need fiscal sanity.' When Democrats are in power, the Republicans suddenly become deficit hawks and then that disappears very quickly. Why is mounting national debt a problem if the U.S. can keep borrowing money essentially for free?

Edwards: A couple reasons. One is most economists think that some big financial or economic crash will come down the road as our debt keeps piling up over the decades. The second reason is just the ethics of it. Borrowing now deficit's debt, pushes costs to the future. You can see that from a libertarian perspective very simply. Right now, if the government has a big spending program, it goes out and borrows 10 billion dollars for a spending program, no one is hurt in the short run. People will get the spending benefit, the creditors will lend more money to the government. They don't mind because they're doing it voluntarily, so no one seems to lose. No one does now. In the future, we got to pay back the debt, the government's got to go out and use its coercion to raise the taxes. From a libertarian perspective, you can see the pain is moved to the future when the government borrows more now, and that's unethical, I think.

Gillespie: Is there some event horizon where we're actually going to cut year over year spending, or is this just kind of smoke and mirrors? Back in the early '90s, George H. W. Bush pushed through a tax plan, which was wildly unpopular. He had made a 'no new taxes' pledge. All the Republicans, all conservatives, all libertarians said he was a sucker because he made the rookie mistake of raising taxes now in the name of spending cuts down the road and the spending cuts never come. Now we're in a world where we're doing tax cuts with spending cuts promised. Are we just these big suckers?

Edwards: Perhaps there's no relationship between taxes and spending at all. At the federal level, politicians like to cut taxes, they like to increase spending. Maybe there's no relationship. I'll give you one way that the Republican tax cuts, if they go through in the next couple weeks may be positive. That is, it does take the whole tax reform issue off the plate of the Republican politicians for a while. For many years, Republican politicians, they can prove their conservative bonafides by claiming they're for big tax reform, and it's always a crowd pleaser with Republican voters.

Gillespie: But they don't actually have to do it?

Edwards: You're right. They keep saying, 'We're going to do tax reform down the road.' This sort of does take it off the agenda, I think, for a while. A lot of this is going to depend on what the Trump administration does. Trump has a very good budget director, as you know, who is pushing spending cuts. I think Republicans put a tax cut in the law before Christmas this year, then the next year it does open up the spending cutters on Capitol Hill to really push more for spending cuts. I'll give you an example of that. The House Freedom Caucus now, the most conservative members in the House, they're holding their fire now on spending cuts because they want the tax cut to go through first. The tax cut goes through, sign in the law, I think it's going to really open up the scenarios for spending cuts.

Gillespie: To make meaningful spending cuts, you got to go where the money is, and that really means old age entitlements, Medicare, and social security, and defense spending. None of those seem to be anything that Republicans are known for even pretending that they want to cut. Will those be on the table, assuming tax reform goes through?

Edwards: To Trump's credit, he actually does go after some of the entitlement. Social security disability insurance is an 150 dollar billion program. It is a giant spending program and it's hugely wasteful. What it does is, it has encouraged millions of Americans who only have marginal disabilities, who should be in the workforce, it's kept them out of the workforce even though really, they should be in the workforce, a lot of them want to work, but if you take any disability money, you essentially can't work. It's a crazy system. Trump has proposed reforms on that system, to his credit. That is the type of reform that I think could move ahead next year.

Gillespie: We'll leave it there. Thank you so much.

Edwards: Thanks a lot, Nick.

Gillespie: We've been talking with Chris Edwards. He's the Director of Tax Policy at the Cato Institute, and he's looking forward to tax reform and spending reform.

Edwards: Absolutely.

Gillespie: For Reason, I'm Nick Gillespie.