Tax cuts: the Laffer Curve strikes again

Donald Trump © Getty Images
Trump’s tax cuts have been a success

When Donald Trump slashed taxes, pundits predicted doom. They should have known better, says Matthew Lynn.

The federal deficit would be blown sky high. The dollar would plunge. The economic recovery would stall as austerity started to bite, and public services would grind to a halt. When President Donald Trump pushed through one of the boldest tax-cutting programmes in recent history – including almost halving the corporate rate – there were plenty of predictions of catastrophe. So how’s it going?

Funnily enough, it turns out that tax receipts are booming. The Laffer Curve, which famously predicts that in the right circumstances cutting taxes can lead to higher revenues, has been proved right once again. With his late-night tweet-storms and legal battles with porn stars, Trump might well be an embarrassment to his office. But his tax reform has been the most significant in the US for a generation or more.

A record-breaking tax take

Trump’s cuts to corporation tax were the most important, taking the wildly uncompetitive rate of 35% down to 21% in a single move, with an even lower charge on companies that decide to bring revenues back onshore. But although that captured the biggest headlines, there were also significant cuts to inheritance tax and an expansion of child tax credit, as well as some reductions to the personal rates – for example, the top rate of tax dropped from 39% to 37% and the threshold for paying it went up to $500,000.

And the result of all this? April, the first proper month of collection since the legislation was passed by Congress, broke all records. The government reported record tax revenues and its largest monthly surplus, as well: it took in $510bn and spent $296bn, leaving a surplus of $214bn (the previous record surplus was $180bn in April 2001). Tax receipts were 12% higher than they were in April last year. Not bad when growth is less than 3%.

True, those figures are slightly distorted. The tax reform was widely discussed before it was passed by Congress, so especially in areas such as inheritance tax, individuals and estates may well have shifted income around in anticipation of lower rates to come. And corporate tax planning works over several years, so it would be naïve to expect there to be a huge impact in the first couple of months after it was implemented. Even so, it was an impressive jump in revenue, and one that most mainstream forecasters did not predict. And there should be more, not less, to come, especially from corporations, as more and more decide to report a greater share of their income in the US.

An example to follow

Other countries should learn from this. In Britain, for example, we collected almost 50% more money last year with a corporate tax rate of 19% than we did when it was 28% under the last Labour government. When we cut the top rate of personal tax from 50% to 45%, the amount raised from the richest taxpayers went up rather than down.

We will find out in the next few months what the medium-term impact of Trump’s tax cuts will be. Maybe there will be some reductions in federal income. But it is already looking as if there will be a significant rise in overall revenues, and that may turn out to be even stronger if it prompts an upturn in investment and entrepreneurship – and there is already some evidence that lower rates are stimulating both.

That will matter to the global economy in two ways. First, it might well put the US on track to a budget surplus. At under 3% of GDP, the US is not an especially profligate country any more, although its debt-to-GDP ratio is rising faster than it should do with an expanding economy. It wouldn’t take much of an upturn in revenues for the budget to come into balance for the year. Next, it might well inspire others – if the US can fix its budget deficit by cutting taxes, what’s to stop others? In fact, the real question might now be how it spends the money – and how long it will take other countries to follow.

  • PAaron

    According to the Congressional Budget Office, the US deficit for the year ending 30 Sept 2018 is projected to be $804 billion. In order to close that gap, taxes would have to increase by about 4% of US GDP. Since the federal government takes about 20% of US GDP, and has been doing so for many years, wiping out a deficit of $800 billion would imply that the US GDP would have to increase by ~$4 trillion in one year, which constitutes an annual growth rate of 20%. I therefore question to statement that ‘it wouldn’t take much of an upturn in revenues for the budget to come into balance for next year’.

    • Galileo2

      The CBO figures are BS. They always have been as the CBO consistently underpredicts the performance of the economy. The staff needs to be replaced with people who know what dynamic scoring is.

      • PAaron

        I guess we’ll have to wait and see.

      • doug

        The CBO is a joke. They don’t show their work and they overvalue Democrat opinions, “Obama care will save money” and undervalue Republican opinions ‘The deficit will go soar’ It is time for Congress to get rid of the CBO and hire out financial advice to a company with a proven track record. If the CBO was a private company no one would hire them.

  • Kevin Hoque

    I am very interested to see how this tax cut works out in the medium to long term. Let’s re-evaluate this time next year. A different picture may emerge.