The recipe of Reagan: how to balance the decline in tax revenues

Mr. Feldstein, Chairman of the Board of advisors for economic Affairs, Professor at Harvard University and one of the authors of The Wall Street Journal

The Minister of Finance Steven Mnuchin (Steven Mnuchin) calls the administration’s offer to trump on tax cuts “the biggest tax reform in the history of our country.” Under the proposed program, profit tax rate will be reduced from 35% to 15% and individual tax, increased under presidents Obama and Clinton, will return to the previous level.

This statement is the first step to the draft budget proposed by the White house that combines the tax plans of the President with the reforms of the defense budget and domestic policy, including the ObamaCare program. If this budget is passed, it will encourage business investment, increase productivity and improve real wages. He also correct the situation with a reduction in readiness due to the increase in defense spending from 2.6% of GDP, at least, once again to 4%.

The challenge is to accomplish that without increasing long-term tax problems. Federal government debt has more than doubled over the past ten years, reaching 75% of GDP. According to the calculations of the congressional Budget office, debt will rise to more than 100% of GDP in the next 15 years even without a reduction of income taxes or increase the defense budget.

A higher level of budget deficit may lead to higher long-term interest rates, could provoke the collapse of the unstable financial markets and the severe downturn in the economy. The current volatility in the markets reflects revalued assets (the ratio of price to earnings per share, according to estimates by Standard & Poor’s, is now at 70% above the historical average) after a decade of artificially low interest rates set by the fed.

Republicans expect to spend your tax project through the approval process in the Senate, but it has its pitfalls. If the project will lead to the deficit beyond the ten-year border force, the law on audit, which will put an end to tax cuts for the tenth year. To prevent this, the GOP members of Congress propose to balance the loss of income from taxes due to changes in the taxation of the citizens, rejecting all tax deductions except charitable donations and interest on a mortgage. This means that new revenues will come from one third of taxpayers who make itemized deduction — from families with higher incomes, given the promise Mnuchin that the tax project is not going to be a gift for the wealthy.

In addition to reducing corporate taxes, the President, the trump offers a similar affiliate tax cuts for business and individuals, engaged in entrepreneurial activities without forming a legal entity. Republicans in the House of representatives also promised to allow U.S. companies to repatriate earned abroad profits after income tax without penalty.

It will be difficult to prevent budget deficits due to tax cuts. Corporate tax increases the income of almost 2% of GDP. Tax reduction in two-fold increase in the annual deficit by almost 1% of GDP, 200 billion dollars. Accelerated economic growth through increased investment will bring additional tax, but probably only about $ 50 billion a year.

Congressional Republicans propose to balance the remaining $ 150 billion is resorting to the system of discounts with tax fees: 20% fee combined with a 20 percent subsidy on exports. This will allow to collect about $ 120 billion per year, enough to balance most of the net cost of corporate tax reduction.

Classical Economics suggests that the law on the system of discounts with tax fees will increase the value of the dollar, reducing import prices enough to balance the 20 percent tax. The Americans, therefore, will not notice changes in the cost of imported products. The stronger dollar will not affect the net value that the American exporters receive for the goods sold abroad. Discount system with tax duties, thus, is a true means of raising the income at which the tax is imposed on foreign companies exporting their goods to USA.

However, the value of the dollar may not rise as much as foreseen in the theory, so American importers and retailers are lobbying against the system of discounts from the tax duties, while the largest exporters are lobbying for it. Without this system, however, the lower rates for corporations will add more than $ 1 trillion to the national debt of the United States in the next ten years, reducing the positive impact of tax reform on capital formation and threatening by raising interest rates.

To reduce the deficit will be possible only by way of slowing down the development of Medicaid, Medicare and social security. The projects of these programmes currently amount to 10.4% of GDP in the next ten years if current laws should be increased to 12.9%. Subsidies for insurance under the ObamaCare program and the expansion of the Medicaid program now costs the Federal government more than $ 200 billion a year. Reform must make a significant contribution to reducing the deficit, although this will not be enough to compensate for all the suggestions trump.

Adopted by the two parties during the Reagan administration the social welfare legislation is a useful historical example of how to compensate for the increase in the deficit. The 1983 law increased the age criterion to receive all social benefits from 65 to 67, while still allowing for equivalent payment at an earlier age. Increasing age was conducted in several stages and began after significant delays.

In the last few decades life expectancy at the age of 67 has increased by three years. The repetition of the reforms of Reagan on a gradual increase in the age for receiving full social security from 67 to 70 years for those people who are today not yet 55 years of age, reduce annual cost of welfare programs by about 15%, or 1% of GDP. Together with the reforms in the sphere of the Federal budget on health care this will be enough to fill the budget hole created by tax reforms and increase in the defense budget.

The increase in the age for receiving full social benefits would also prevent a crisis in the program, which, according to forecasts, can occur in 2029. Then trust the social security Fund is exhausted, which would require either an immediate reduction in payments by 30% or sharp tax increases. A gradual increase in the age for receiving social benefits will be the best way to prevent crisis and reduce projected fiscal deficits.


Mr. Feldstein — Chairman of the Board of advisors for economic Affairs, Professor at Harvard University