Prof. Oren M. Levin-Waldman will discuss his most recent article: “The Unstated Assumption Underlying the New Tax Law” By Oren M. Levin-Waldman, on Wednesday, January 17, 2018th at 10am EDT on the Westchester On the Level radio broadcast. Listen “Live” or “On Demand”. Use the following hyperlink … http://tobtr.com/s/10521941 … to listen, make an inquiry, or share your perspective by calling 347.205.9201. Participants are asked to be respectful of all our guests and to stay on topic. This segment will air from 10-11am.
“The Unstated Assumption Underlying the New” Tax Law By Dr. OREN M. LEVIN-WALDMAN, Ph.D.
The so-called tax reform that was recently signed into law rests on a set of assumptions with strong grounding in economic theory. The first is that if corporate taxes are cut significantly, firms will now have more to invest and will thus create jobs. In fact, it is assumed that growth in the economy will result in wages rising. And the second is that if people have more money in their pockets because they are paying less in taxes, there will be further growth because they can spend more due to greater purchasing power.
The second assumption may be partly true to the extent that greater purchasing power increases aggregate demand for goods and services. But this may also be limited because although those at the bottom of the distribution will surely spend the extra money, it isn’t a given that those at the top of the distribution necessarily will. They may be more likely to throw additional after-tax income into savings. Moreover, those who spend at the bottom are more likely to spend on necessities, rather than durable goods which is what really drives the economy.
The first assumption, however, may be a bit of a stretch. There is no guarantee that firms will take the savings from significant tax cuts in corporate taxes and create jobs as opposed to paying greater dividends to shareholders. Firms will only invest in new plants and equipment and create new jobs if there is a demand for the goods and services that they are selling. While greater purchasing power from across-the-board tax cuts may help in this regard, it probably isn’t nearly as effective as measures aimed at increasing wages.
On the question of rising wages in a climate of general economic growth spurred by tax cuts, one wonders if there isn’t also some moral hazard. In theory when productivity rises wages should rise too. But that is not what has been happening in recent years. Since the end of the Great Recession, productivity has increased but wages have not. This would imply that rather than sharing productivity gains with workers in the form of higher wages, managers have simply been pocketing them.
The question that arises is might employers opt not to raise wages on the assumption that their workers have more in their pockets due to tax cuts? Since workers will have higher after tax income, then why would there be a need for employers to raise wages? In other words, we have no grounds for assuming that wages will necessarily rise. In fact, as the cost of benefits like healthcare continue to rise, it may be reasonable to assume that money wages will not.
Still, there is yet another assumption that has not been spoken about but does warrant discussion. One of the major changes is the elimination of state and local tax deductions and the capping of property tax deductions at $10,000. We have heard considerable opposition from politicians in high tax states like New York, New Jersey, and California that the residents in their states will be paying considerably more in taxes. In other words, the blue states, where state taxes and property taxes are much higher, are the real losers in this so-called tax reform.
Is it possible that the architects of this new tax law assumed that with the loss of state and local tax deductions the high-tax states would be forced to cut taxes and hence spending? It would no doubt be easier to claim that the Republican controlled Congress deliberately set out to stick it to the residents of these states, and their politicians because they are Democrats. Of course, nobody would ever say that American politics is driven by spite.
Still, there is a serious question here: will there be greater pressure on politicians in these states to reduce taxes which will mean cutting social programs in these states? Of course, this raises yet another question: have these states over the years been increasing their spending and taxes because they knew that residents could deduct the higher taxes from their federal taxes? Of course politicians in red states could easily have done the same.
Nevertheless, data from the National Tax Foundation show taxes in blue states to be higher than taxes in red states while investment in infrastructure is less, and the cost-of living is considerably higher. The question has long been why blue state voters have been willing to pay higher taxes. We can only speculate that blue state voters have been willing to pay higher taxes because they have been able to deduct them from their federal taxes.
Although state and local deductions have clearly been of benefit to high tax blue states, there is nonetheless a moral issue here. That is, why should taxpayers in lower tax states be forced to subsidize the spending in these higher tax states? After all, with these deductions, the federal tax burden in red states is effectively higher. Well no more.
What, then, might be the consequence of the elimination of these deductions? Some have speculated that there may be migrations from blue states to red states. If this happens, there could conceivably be a reduction in real estate values. There may be some migration, but those who are tied to their jobs won’t easily be able to migrate. The more likely scenario is that we will see a new form of politics emerge around tax cutting at the state and local level.
In other words, it is conceivable that we could see a return of the Proposition 13 movement which originated in California in 1978. Then California voters passed this proposition that would reduce property taxes by 57 percent. State and local politics has often revolved around development and redevelopment. In efforts to court outside investment, state and local politicians often seek to create “favorable” business climates which often entail lower taxes, reduced social services, and the contracting out of municipal services .
The pressure to reduce taxes further may lead to more austere state and local budgets because spending will have to be cut in order to accommodate even lower taxes. This could lead to even greater strife over budgeting priorities and further exacerbate inequality. Inequality, however, was never an issue that was going to be solved through tax reform of any kind. Only higher wages have the potential to reduce rising income inequality.
Economics is not really about stock values and unemployment rates, but about behavior. How do actors in the market place respond to stimuli, which in this case is a product of deliberate policy choice. If the architects truly believed that eliminating state and local tax deductions would force states and localities to reduce taxes, trim their budgets, and cut social programs, they were clearly making a sound assumption grounded in economic theory. But the politics surrounding budgets, taxes, and social programs often bear little relationship to economic theory. One thing is for sure: we are in for some interesting political battles to be fought at the state and local level.
Dr. Oren M. Levin-Waldman, Ph.D., Professor at the Graduate School for Public Affairs and Administration at Metropolitan College of New York, Research Scholar at the Binzagr Institute for Sustainable Prosperity, as well as faculty member in the Milano School for International Affairs, Management, and Urban Policy at the New School. Direct email to: email@example.com.