Here’s an interesting headline from Bloomberg News: “Trump’s Tax Law Rankles Europe as Ministers Fret About Fallout.” The story, from Tuesday, noted that European finance ministers were concerned about the impact of the Tax Cuts and Jobs Act.
The most notable feature of that legislation is a much-lowered corporate tax rate, and that’s what the Europeans are riled up about.
{mosads}In the words of Germany’s acting finance minister, Peter Altmaier: “We will closely assess the economic effects. We want to avoid companies moving their headquarters from Europe to the U.S. and we want to avoid investment flows being redirected.”
So there you have it: Americans have finally done something to make their economy more competitive, and the Europeans aren’t happy.
Interestingly, the gist of the Bloomberg article was that Europeans are likely to respond to this new “American Challenge” with legal action, as opposed to economic action.
In the words of Pierre Moscovici, the European Union’s economic affairs commissioner: “We have doubts and questions about compatibility with World Trade Organization rules and need to look at that in depth and come back with a further exchange of views with our American friends.”
In other words, the Europeans will be looking to the WTO to negate the new American edge.
Without a doubt, the American tax cut has set the world in motion. That, of course, has been the argument of the American tax-cutters all along: A change in tax rates brings about a change in behavior and thus in the competitive status of nations.
Economists who study the behavioral effect of tax rates have been called “supply-siders,” because they focus on the impact of rates on supply, i.e., the supply of work, savings and investment. In particular, the lower the marginal tax rate — the tax on the next dollar earned — the more likely it is that supply will grow, because production is maximally rewarded.
Perhaps the best known of these supply-siders is Arthur Laffer, who burst to prominence as an adviser to Ronald Reagan in the late 1970s.
As Laffer wrote in a monograph for the Heritage Foundation, supply-side thinking “recognizes the positive impact that lower tax rates have on work, output and employment — and thereby the tax base — by providing incentives to increase these activities. Raising tax rates has the opposite economic effect by penalizing participation in the taxed activities.”
In other words, lower rates equals higher growth, and higher rates equals lower growth.
Few economists would dispute that lowering tax rates has at least some positive effect. In fact, even the Obama Treasury Department agreed that lowering corporate tax rates would help the economy.
A 2015 study concluded, “Our estimates suggest that lowering the corporate tax rate from 35 percent to 25 percent would increase firm value by 16 percent.”
Interestingly, the Obama administration proposed a lower corporate rate at various times, even if it never followed through with a true push.
Yet as supply-siders would say, if action on tax rates has consequences, so, too, does inaction. As a result of the Obama administration’s inaction, the American economy was left stranded by the highest corporate tax rate in the developed world.
Moreover, that lack of corrective action had its own economic consequences. According to the Commerce Department, America’s GDP growth in 2016 was a mere 1.5 percent; without a doubt, such a halting number was a drag on Democratic political fortunes that November.
As we all know, the Republicans came into unified power last year with a mandate to cut tax rates, thus changing the growth equation. In fact, the stock market — often seen as a leading indicator of future economic trends — is up about 25 percent since Election Day 2016. In the meantime, GDP growth last year jumped by more than half from the year before, up to 2.3 percent.
So we can see: The tax-rate reductions have had exactly the stimulative effect that supporters were hoping for. Indeed, House Majority Whip Steve Scalise (R-La.) is maintaining an ever-growing list of companies that have shared their tax-cut gains with their employees.
To be sure, other companies have made other uses of their addition money, including buying back their stock, but that’s the free-enterprise system in action.
Today, the American economy is surging: Capital is once again coming to America first. President Trump himself tweeted on Tuesday, “Companies are pouring back into our country, reversing the long term trend of leaving.”
Of course, the supply-siders’ argument, all along, has been that rate cuts would change behavior by improving incentives for production, thereby improving the economy, and the American people are starting to take notice.
The New York Times reports that a new poll finds that public support for the tax bill has risen sharply, from 37 percent in December to 51 percent in February.
Yes, that still leaves plenty of Americans opposing the tax bill, including most Democrats. Yet, even if the Democratic Party does well in future elections, the increase in popular support for the tax bill will surely restrain, if not stymie altogether, any concerted effort to repeal the tax bill.
It’s just that prospect — that the American tax cuts are here to stay — that has the Europeans squirming.
James P. Pinkerton served as a domestic policy aide in the White Houses of Presidents Ronald Reagan and George H.W. Bush. From 2011 to 2018, he was the co-chair of the RATE Coalition, a group that advocates for a more competitive tax code.