Tax Reform and Financial Growth

President Trump's recently enacted tax reform
legislation shows great promise regarding
enabling economic growth in both the short
and long term. With the final legislation signed
by the president there is a reduction in the
marginal tax rates, which is critical to facilitating
the promised economic growth.

The Tax Policy Center, a think-tank which focuses
on national tax policy, reckons that the weighted-
average marginal tax rate from individual income
and payroll taxes will decline in 2018 by 3.2%.
Moreover, the TPC discovers that the marginal tax
rates will drop for taxpayers across the income
distribution, so that whomever pays any income tax
(and will be paying income tax this year) will get
this beneficial easement. Robert J. Barro, professor
of economics at Harvard University and a visiting
scholar at the American Enterprise Institute, states
that he finds that the tax reform package relies on
the "user cost of capital"; this is a concept economists
utilize to get a fix on what the cost is for businesses
to acquire and deploy capital. This return is high,
roughly around 8% per annum in real terms, the reason
being that investing involves large risks.

The tax rate on corporate profits will be reduced from
35% (the highest such rate in the world) to 21%.
The degree of expensing allowed on business investments
will be impacted by this rate cut. On equipment, the new tax
law raises the depreciation allowance will be hiked from
80% to 100%, with this change to lapse after five years.
On structures, the depreciation allowances will also be
considerably discounted. Although the new tax legislation
does not change depreciation schedules for structures such
as factories and office buildings, the lower tax rates come
into play because whatever output comes about from
investment is taxed at the new rate of 21% -- a nice break.

When the user cost of capital is lowered, the long-run ratios
of corporate capital to labor are increased. This means that
companies will be more able and willing to provide each
worker with more structures, along with more equipment
in those structures, to do their jobs. This makes raising wages
possible by cutting corporate taxes.

Prof. Barro thus finds that cutting income taxes on individual
taxpayers will fuel economic growth in the short term, and
tax reform with an eye toward lessening the tax load for
businesses will fuel that growth over the long term. This
makes for more investment, increased production and
higher wages for millions of American workers. After the
eight years of punishing taxation and a resulting paucity of
investment capital courtesy of President Obama, this plan
will be a welcome breath of fresh air.


MEM