The Tax Cut Heard Round the World
Once Trump was sworn into office, he was ready to hit the ground sprinting, as is his signature style. But Congress sure wasn’t on board. The tax bill couldn’t have gotten off to a worse start on Capitol Hill. There were many times throughout a tumultuous 2017 when it looked like the tax bill was a lost cause. That said, as Ethel Lina White wrote in The Wheel Spins, “Lost causes are the only causes worth fighting for.”
A big part of the problem was that the Trump White House decided to defer to Republican congressional leaders, who made a lousy decision right out of the gate. Speaker Paul Ryan and Majority Leader Mitch McConnell decided to pursue Obamacare repeal first, deferring the tax cut to the second half of 2017.
This made us nervous. We argued against it, to no effect.
Arthur and Larry had lived through the 1981 tax battle and remembered the lessons many in the party had evidently forgotten. Reagan had smartly announced that his historic tax cut would come first, and then the budget battle and other priorities thereafter.
Had Reagan reversed his priorities, the tax cut, and with it the booming prosperity that ensued for seven years, may never have happened. It was the tax cut that helped create a ferocious economic comeback, which helped Reagan amass enormous political capital, and then led to his landslide reelection in which he won 49 states—the biggest blowout reelection in modern times. Follow the Reagan political formula, we urged.
We were very much in favor of repealing every word of the disastrous Obamacare experiment, one that had the opposite effect of making healthcare “affordable.” That said, we didn’t see why Congress couldn’t walk and chew gum at the same time.
Time was not on the newly elected president’s side. Any delay in passing the tax bill risked slowing the path to real economic recovery. The longer the delay, the lower the odds of getting a tax cut passed at all. Presidents who got their agendas passed did it right away. Reagan led with his tax rate cut and signed it into law in August 1981. Obama signed his enormous $787 billion “stimulus” bill four weeks after taking office. The political capital from winning a presidential election needs to be deployed fast lest it dissipate.
In our meetings with Trump and the White House brain trust, we urged that Trump weigh in and call for a tax cut to come to his desk in the first 100 days of his administration. We felt that a robust debate over tax reform on the Senate floor would be a good thing, forcing members to deliberate, offer alternatives, and vote.
Republicans were flinching from the “tax cuts for the rich” attacks by the Bernie Sanders crowd. But such claims could be countered effectively. The president’s new chairman of the Council of Economic Advisers, American Enterprise Institute economist Kevin Hassett, had assembled solid evidence showing that business tax rate reductions would mostly benefit workers through higher wages.
Upward income mobility for workers was the president’s primary objective. It was our objective. It was what the American people wanted and voted for. It’s an argument we were certain we could win.
So bring on this debate, and the sooner the better. But the delays continued, and Wall Street and the business groups were getting nervous. By early summer, the business lobbyists and the financial gurus were betting that tax cuts wouldn’t even happen in 2017. In a meeting with White House and congressional tax writers in the early summer, we took a tough stance and scolded GOP leaders for dragging their feet. Our pitch was that a delay until 2018 would hurt the economy, hurt the financial markets, and put the Republicans in a precarious position for the midterm elections. That got their attention. For a while.
Whose Tax Bill Is This Anyway?
Another hurdle we had to clear was dealing with the congressional leadership in the House. Speaker of the House Paul Ryan, whom we had worked with and admired for years—dating back to when he was a junior staffer working for the great Jack Kemp—had written for House Republicans something called the “Roadmap” to tax reform the year before the election. House Ways and Means Committee chairman Kevin Brady of Texas was also totally committed to tax reform and a pit bull in getting it done, and deserves enormous kudos for his leadership, right through to the final victory, working hand in hand with Paul Ryan.
The House Roadmap plan was a bold wholesale revamping of the tax system. Most of the ideas were sound, though some were controversial. The problem was that no one had ever heard of the Roadmap. It was different in many ways from what Trump had campaigned on. So there was a political disconnect between what Trump had promised during the campaign—presumably what the voters had elected him to do—and Paul Ryan’s unsung Roadmap.
Ryan was intent on enacting his Roadmap, not the Trump plan. There was much overlap but major differences on rates and deductions. The Roadmap was more grandiose, and it had more moving parts and more controversial items, including the wholly novel border-adjustment tax. The House Republicans were also obsessing about revenue neutrality. We worried that this undue emphasis was a trap, given that, calculated on a static basis, tax cuts raise deficits.
Our view was that the House should run with the plan that got Trump and so many other Republicans elected and not start throwing curve balls.
What really threw a wrench into the tax cut roll-out strategy was that the GOP was busy botching Obamacare repeal. Congressional leaders had told Trump to let them handle Obamacare repeal (as they were doing on tax reform). They promised to deliver a first-rate repeal to his desk for signature.
The Republicans failed to repeal Obamacare because they couldn’t agree on an alternative. The process bogged down and then broke down.
By the spring and through midsummer, tax reform wasn’t even out of the gate. We were in a state of extreme agitation. What was supposed to be a first 100-day policy victory was nowhere to be seen 200 days into the new administration.
The defeat on Obamacare repeal in the Senate (by one vote), combined with Trump’s rising anger about his signature tax reform languishing, wound up being a turning point. There was no room for swinging and missing on tax reform after whiffing on healthcare reform.
Failure would be a political and policy catastrophe. Trump had to take the reins away from Congress. Trump was needed as the chief spokesman and negotiator or tax reform wasn’t going to happen.
The Border-Adjustment Tax Imbroglio
Then there was the giant distraction of the border-adjustment tax. The highly controversial issue almost brought down the entire tax cut effort.
A few weeks after the election, Steve was giving a talk at the Economic Club of Minneapolis to discuss Trumponomics and the economic agenda of President-elect Trump. The night before the speech, he received an urgent call from the Economic Club president asking if he could have breakfast the next morning with Hubert Joly of Best Buy and Brian Cornell of Target—two of America’s most respected national retail chains.
It was flattering that they wanted to meet. He readily agreed.
After ten minutes of pleasantries, they made their real agenda clear. They wanted to talk about the border-adjustment tax, aka the BAT.
This was the House proposal to impose a tax on U.S. imports and exempt U.S. exports. This would be a big tax break for U.S. manufacturers and very bad news for importers—i.e., retailers like Target and Best Buy. These two gentlemen walked Steve through the math.
Retailers were getting squeezed by online competition from Amazon. The big-box stores had very slim margins. A 15 percent tax on the cost of their merchandise would potentially put them into bankruptcy. This was live-or-die for these firms, they argued. It would lead to higher prices for consumers.
It was a friendly conversation, and their case struck Steve as somewhat exaggerated. Yet there was no doubt retailers were fearful and would fight to the death to prevent this tax from happening. They mentioned that Walmart was in a complete go-to-the-mattresses mode on the BAT. The Retail Federation would spend whatever it took to defeat it.
Putting aside the merits of the opposition, as a political calculus, how were we going to pass a tax bill through the Senate when there were only 52 Republicans and two of them were from Arkansas, home of Walmart?
We had a giant political headache on our hands.
House Ways and Means Committee chairman Kevin Brady and House Speaker Paul Ryan—two of the true heroes of the tax reform epic—saw the border-adjustment tax as the trillion-dollar “pay-for” to offset the cost of expensing and rate reduction. Because we import about a half-trillion dollars more than we export (the merchandise “trade deficit”), by taxing imports and exempting exports, the government would raise about $1 trillion more revenues over a decade. This would significantly reduce the net deficit impact of the tax cut.
Conservatives were split on the issue. In fact, Arthur, Larry, and Steve couldn’t even agree on it—and we generally agreed on almost all tax issues. A family fight was brewing just at the time when a unified front became crucial.
Steve was for the tax as a matter of policy. Arthur was for a value-added tax model that would replace taxes on personal and corporate income and incorporated a BAT, but he also saw a preclusive technical flaw in the BAT. In a research paper Arthur published in March, he made the point that “the supposed ‘pay for’ rule now in effect in Congress is the bastard father of the border-adjustment tax.”1 In other words, the “pay for” requirements were forcing Republicans to invent ways to make up for supposed static revenue loss that would surely have deleterious effects on the dynamic growth that would come from a tax cut. Larry was against it from the start, as he and our compadre Steve Forbes saw it as a hidden national sales tax that would massively increase the government’s tax take of the economy.
There was some ingeniousness to the idea, and a strong economic justification for it. The BAT was designed to correct one of stupidest features of our corporate tax: the backward way we tax international transactions.
Consider this simple example: If you are an American company making cars in Michigan, you have to pay a 35 percent profits tax on the car made here. Then if the car is sold across the border to Mexico, the Mexican government slaps on a 16 percent value-added tax. So the car is taxed on both sides of the border. Almost all countries tax goods produced in the United States this way.
Now let us say that the auto factory is moved from Michigan to Mexico City. The car produced in the factory in Mexico is not taxed by the Mexican government if the car is sold in the United States. Even more amazing: the United States imposes no federal border tax on the imported car. To summarize, the car is taxed twice if it is built in America and then sold abroad and never taxed if it is built abroad and sold here in the United States. Little wonder why American companies are moving to China, India, Ireland, Mexico, and the like. We were stacking the deck against American producers and workers. Our federal tax was effectively a 35 percent tariff imposed on our own goods and services.
As we saw it, there were three economic arguments in favor of the BAT:
- It could end all talk of tariffs and trade wars. At various times, Trump has suggested between 5 and 35 percent tariffs on foreign goods imported here. But tariffs violate our trade agreements and often lead to retaliatory measures by other countries. A better solution is to impose the Trump 15 percent corporate income tax on goods when they are brought into the United States and to exempt goods produced in the United States that are sold outside the country. This tax does not violate trade laws and only mirrors the valued-added tax systems other countries use to gain advantage over us.
- A border-adjustment tax has a broader tax base, and thus the rate can be lower. The best tax system has a broad tax base and a low tax rate. To get the Trump tax rate down to 15 percent and still raise enough money to fund the government, we need the broadest tax base possible.
- A border-adjustment system taxes consumption, not production. Most economists agree that a good tax system taxes what people take out of the economy, not what they put into the economy. Many Keynesian economists have long argued that consumption is what drives the economy, but American consumers can’t consume if they aren’t producing something.
Steve argued that in exchange for a border-adjustment tax, the United States should eliminate all existing tariffs and duties, which now range from 2 percent on shoes to 25 percent on toys. This would eliminate all special-interest favoritism—the worst feature of trade protectionism.
These arguments may or may not have made sense as an economic matter, but as a political matter the BAT was a poison pill. Instead of focusing on the positive changes from tax reform, voters and conservative interest groups were focusing on this new Big Bad Tax. The business community was completely divided. As such, we all agreed very early on that the BAT had to go.
One of our contributions to the tax debate was to persuade the White House—which had been undecided on BAT—and, even more importantly, Paul Ryan and Kevin Brady, that the BAT had to be abandoned or tax reform would be stillborn. They finally threw in the towel, but not before Arthur personally went to Chairman Brady’s office at the end of July to stick the nail in the BAT coffin. They still grouse to us whenever we see them that they were right on the BAT. Perhaps in a technical sense, they were.
But what we all agree on was that while the economics were debatable, the politics of the moment were not. Including the BAT would have killed any prospect of passing the tax bill in the Senate. It had to go.
The Late Great Trump Tax Cut
It should be noted that in the spring and summer, Larry, Steve, and Arthur were working together but separately. Larry and Steve were going around Capitol Hill as a dynamic duo, while Arthur was doing his own meetings with legislators and members of the administration. One time in July, Arthur met with seven members of Congress individually in a 24-hour period to talk about the merits of the proposed tax reform. Working all angles was absolutely necessary because by late spring of 2017, the signature Trump/GOP growth issue—tax reform—was secure in some undisclosed location . . . probably bleeding to death in a ditch.
Republicans were starting to openly whisper they might have to put tax reform off until 2018. Wall Streeters were starting to discount the higher probability that tax reform wasn’t going to happen. Could it be that Republicans were going to blow a once-in-a-generation opportunity to rewrite and modernize tax law?
At this time, Arthur was working to spread his research on the corporate income tax rate to those in D.C. who would listen. In May, he met for an entire day with White House staffers to explain to the whole team the economic necessity of the 2017 tax reform. In June, he spoke in front of a roomful of members of Congress and delivered the same message. He came armed with an influential study which broke down the revenue-increasing behavioral effects of a reduction in the corporate income tax rate. This was crucial to get the deficit hawks on board.
On one of our various visits to Capitol Hill for high-level meetings with both chambers of Congress in the early summer, our message to GOP lawmakers contained some good news and some very bad news from recent private polling on the tax cut front.
The good news was that by a 62 to 30 percent margin, Americans believed that a tax cut would be good for the economy. We were solidly winning the case with voters that a big tax cut for businesses and families means jobs and growth.
The bad news was that when people are asked which party is better able to deliver a tax cut, 36 percent say Republicans and 38 percent say Democrats. That was certainly a wake-up call to Republicans, given that Democrats didn’t even want to cut taxes at all. Voters witnessed the bungled GOP attempt to repeal and replace Obamacare and had lost confidence that a Republican Congress could get anything done.
The GOP was in danger of getting shut out in the first year of a new presidency. This would be a political and policy Hindenburg. But very few members of Congress or our friends in the White House and in the Treasury seemed alarmed or worried . . . no matter how many times we warned them that waiting until 2018 was a recipe for failure.
Every day on the calendar that was flipped over brought the probability of defeat closer. Near the end of the summer we were told that there were only about 25 legislative days left to get this mega-bill enacted. Uh-oh.
President Trump’s tax cut was looking like legislative road kill.
Three Easy Pieces
The three of us gathered in New York City in the spring to adopt a game plan to help resuscitate the tax plan. We were joined by our friend and cofounder of the Committee to Unleash Prosperity, Steve Forbes. We were all in passionate agreement that the delay in the tax debate was bleeding dry any presidential capital that Trump had left.
Our view was that tax reform should be kept as simple and understandable to voters as possible. This meant fewer moving pieces—scrap the Roadmap—and it meant getting back to the basics of what Trump had promised throughout his presidential campaign. We called our plan “Three Easy Pieces of Tax Reform,” and used it to shake off the dust settling inside policy circles . . . and especially among the political team at the White House. Then–White House chief strategist Steve Bannon loved the idea.
We decided to jointly pen an op-ed for the New York Times to jump-start the debate. We were apprehensive because we didn’t want to alienate our friends on Capitol Hill and in the White House. But we had run out of options.
We titled the article “Why Are Republicans Making Tax Reform So Hard?” It ran on April 19, 2017.2 Here is what we wrote:
In the aftermath of the healthcare blowup, President Trump and the Republicans need a legislative victory. Tax reform probably should have gone first, but now is the time to move it forward with urgency . . .
One sure lesson from the healthcare setback is the old admonition “Keep it simple, stupid.” The Republicans tried to fix the trillion-dollar health insurance market instead of keeping the focus on repealing Obamacare.
They have a chance to make amends with a new tax bill and still hit the August deadline. We advised President Trump during his election campaign, and we believe the Republican Party’s lesson for tax reform is this: Don’t try to rewrite the entire tax code in one bill.
Instead, the primary goal of Mr. Trump’s first tax bill should be to fix the federal corporate and small-business tax system, which has made America increasingly uncompetitive in global markets and has reduced jobs and wages here at home. The White House and the Treasury already have a tax plan that we were involved with last year. The three most important planks of that plan are:
First, cut the federal corporate and small-business highest tax rate to 15 percent from 35 percent, which is now one of the highest corporate tax rates in the world.
Second, allow businesses to immediately deduct the full cost of their capital purchases. Full expensing of new factories, equipment and machinery will jump-start business investment, which since 2000 has grown at only one-third the rate recorded from 1950 to 2000.
Third, impose a low tax on the repatriation of foreign profits brought back to the United States. This could attract more than $2 trillion to these shores, raising billions for the Treasury while creating new jobs and adding to the United States’ gross domestic product.
To help win over Democratic votes in the House and Senate, we would also suggest another component: What many workers across the country want most from President Trump is infrastructure funding. As part of this bill, we should create a fund dedicated to rebuilding America’s roads, highways, airports and pipelines, and modernizing the electric grid and broadband access—financed through the tax money raised from repatriation of foreign profits.
. . . For this strategy to work, Republicans need to take several steps. First, President Trump and Paul Ryan, the Speaker of the House, should stop insisting on “revenue neutrality.” In the short term, the bill will add to the deficit. But President Trump’s tax bill, like those of Presidents Ronald Reagan and John Kennedy, should be a tax cut, and it should be sold to the American people as such.
. . . The additional increase in real wages from the Trump plan could be nearly 10 percent over the next decade, which would reverse 15 years of income stagnation for the working class in America. And, if we are right that tax cuts will spur the economy, then the faster economic growth as a result of the bill will bring down the deficit.
Next, Republicans should abandon the so-called border-adjustment tax. A border tax is a poison pill for the tax plan: It divides the very business groups that the party needs to rally behind tax reform. Retailers like Walmart will never go along. A carbon tax would be even worse. The best way to bring jobs back to America is to simply lower tax rates now while rolling back anti-jobs regulations, such as rules that inhibit American energy production.
As for fixing the maddeningly complex individual income tax system—lowering tax rates and ending needless deductions—we are all for it, but that should wait until 2018. Jobs and the economy are the top priority to voters.
Republicans need to act with some degree of urgency. The financial markets and American businesses are starting to get jittery over the prospect that a tax cut won’t get done this year. A failure here would be negative for the economy and the stock market and could stall out the “Trump bounce” we have seen since the president’s election.
Mr. Trump should demand that Congress send him a jobs bill this summer that he can sign into law on Aug. 13, 2017. That is the day President Reagan signed his historic tax cut in 1981 at his beloved Ranch del Cielo in Santa Barbara, Calif.
That tax cut and President Kennedy’s before it unleashed two of the longest periods of prosperity in American history, and that is a result Donald Trump should want to replicate.
The impact of the article was thunderous and immediate. Our friend Fred Barnes, the veteran political reporter and editor of the Weekly Standard, called it the “op-ed that changed the world.”
Actually it would do greater justice to observe that this was “how Ivanka changed the world.” When Ivanka Trump, a key friend and ally, saw the article in the newspaper that morning, she cut it out and put it at the top of a stack of must-read items for the president as he sat down behind his desk in the Oval Office.
President Trump read the piece, marked it up, and called a snap meeting with his legislative, political, and economic advisory teams in the Oval Office. He angrily pointed to the article and said, “This is the way we are going to get it done. They are right, let’s get going on tax reform. No more delays.”
Three days later, National Economic Council chairman Gary Cohn and Treasury Secretary Steve Mnuchin held a press conference and presented the latest version of the Trump tax plan, which looked an awful lot like what had been proposed in the New York Times op-ed. A few days later the president demanded that Congress get a tax bill on his desk before Christmas.
No one had thought that possible a week before. Now the odds of a bill had gone way up. In the following months, Arthur’s own productive meetings with Cohn, Vice President Pence, and Secretary Mnuchin confirmed that there were indeed allies of supply-side economics in the White House once again, and they were serious about pushing reform through.
Rereading our statement nearly a year later, we readily admit there were many things we got wrong. Adding infrastructure spending seemed at the time a smart way to lure Democrats into the debate. That proved a nonstarter. Democrats were in such an intransigent “resistance” mode that they couldn’t be budged to vote for any economic growth tax and spending bill even if it had things they and their constituent groups dearly wanted.
Second, our “Three Easy Pieces” plan was insufficiently ambitious. The final product that passed the House and Senate contained some very valuable changes to the individual income tax system, including a consolidation of the tax rates, a reduction in the top tax rate to 37 percent, and a small business exemption of 20 percent. We acknowledge that we were wrong on these points. Congress exceeded our expectations.
But most of the rest of the points helped focus GOP thinking. Tax cutting was back on the table. More than that, tax cutting was front and center in the policy debate for the next five months. Politico wrote that the “Three Easy Pieces” op-ed was one of the most influential pieces in many years.
But there were still many unresolved issues. The epic was just getting started.
Reconcilable Differences
The next buzz saw we ran into was Charles Schumer, the Senate minority leader. Schumer had announced that the Democrats had zero interest in helping pass the Trump tax cut. He announced that he was confident that every Senate Democrat was a no.
This was a remarkable and depressing development. It also revealed just how far to the left the Democratic Party had slipped. This wholesale partisan “resistance”—as they called it—was unlike the Kennedy and Reagan years. In those golden years, some—even most—Democrats supported tax cuts. The famous JFK tax cut was supported by the vast majority of Democrats and actually was opposed by many Republicans, including that hero of the right Senator Barry Goldwater, who voted no because of the alleged impact on the federal deficit. In 1986 Democrats worked side by side with Reagan to pass the tax reform bill—which cleaned out the tax code of special-interest provisions and lowered the top personal tax rate to 28 percent.
The Senate vote was a remarkable 97–3. In 1986 nearly every Democrat in the Senate—including Ted Kennedy, Howard Metzenbaum, Al Gore, and Pat Moynihan—supported a top tax rate of 28 percent. In 2017 not a single Senate Democrat supported anything below a top tax rate of 40 percent. Cutting the top marginal rate was seen as a blasphemous giveaway to the rich, rather than a valuable and proven way to create jobs and generate powerful upward economic mobility for workers.
Alas, Democrats had officially put themselves on notice that they were now an anti–tax cut party. We say that with no joy. Equitable prosperity is not a partisan issue and should be a bipartisan crusade. President Trump has entered the ranks of John F. Kennedy, Ronald Reagan, and Bill Clinton in enacting smart tax cuts designed to get the economy out of the doldrums and back to growing at 3 percent or more per year.
United Democratic opposition presented a daunting challenge. Could we hold the 52 Republicans together?
The only vehicle to pass a bill with 51 votes rather than the normal 60 required in the Senate was “reconciliation,” a process that allows the Congress to put a target tax cut inside the budget and pass the tax cut with a simple majority of the votes. Everyone understood from the start that reconciliation was vital to the bill’s passage given the Democratic “resistance.”
Reconciliation, in the budget context, is a procedure that dates back to 1974, when, in the aftermath of Watergate, the congressional rules required that the House and Senate budget committees pass a “budget resolution.” The Senate procedures permitted it to pass a tax cut without a filibuster—with 51 votes—as long as the revenue loss was agreed to in advance in the House and Senate budget resolution—called the “reconciliation instructions.”
The 51-vote rule would work as long as Congress passed a budget earlier in the fiscal year that allowed for a tax cut of predetermined size over a particular number of years—in Trump’s case, ten years. Since the reconciliation process allowed deficits only within the ten-year window, technically the tax cuts would have to expire by 2027 if they increased red ink in the years thereafter.
It was clearly not an ideal way to pass a tax cut. But it was the only way. Just as Reagan and George W. Bush had used this process to pass their tax bills, we urged Trump to use this mechanism to pass as big a tax cut as possible. As it happens, Donald Trump does big very, very well.
There was one major drawback to using reconciliation. The law empowered the Congressional Budget Office and Joint Committee on Taxation’s highly flawed economic models to serve as referees and “score” tax bills. History had proven time and again that their perverse rules of “scoring” make it more difficult to reduce marginal tax rates because they always overstate revenue losses. We had made the case showing the actual numbers that over the last 30 years almost every tax hike had overestimated revenues to be raised by the federal government. Almost every tax cut had overestimated the revenue loss from a tax rate cut. The 1997 capital gains tax rate cut had been “scored” to lose tens of billions in revenues. Once enacted, that rate cut led to massive gains in tax receipts because people were willing to sell shares and realize (pay tax on the gains) once the rate was no longer confiscatory.
As for the Trump tax cut, we argued for a “tactical nuclear option inside reconciliation” that would throw out the broken static models and replace them with dynamic scoring that recognizes the positive impact of lower tax rate incentives on growth. The CBO was estimating real economic growth over the next ten years that would continue to stagnate at a 1.8 percent annual pace. However, looking at history, we could see that growth would increase with more take-home pay and handsome rewards for business. Our advice was to plug 3 percent growth into the models. This was perfectly consistent with what Trump had been saying since day one on the campaign trail. (In fact, Trump was consistently pushing for policies that he hoped would bring the growth rate to 5 percent!)
So . . . let Trump be Trump. Instead of assuming that the Trump tax cut would fail, we told congressional Republicans to have courage in their convictions, which were well supported by history. The prosperity under JFK, Reagan, and Clinton predicts that a tax cut would succeed in generating powerful economic growth.
Why not 3 percent growth rate over the next ten years? Three percent is still below America’s long-run average. But if you slash tax rates, particularly on large and small businesses, it is reasonable to assume more investment, new companies, profits, productivity, wages, and job creation. It is not just reasonable to project 3 percent real GDP growth. It is conservative.
Faster Growth Means Lower Debt
To hammer home this point and to get the deficit hawks—such as Senator Jeff Flake of Arizona and Senator Bob Corker of Tennessee—in our corner, we published a piece in the Wall Street Journal that sparked a lot of attention. It pointed out that the long-term deficit forecasts showing an alarming surge of the national debt over the next two or three decades only underscored why the nation so direly needed faster growth. Here is what we wrote in our piece from April 25, titled “Growth Can Solve the Debt Dilemma”:
The Congressional Budget Office’s latest report on the nation’s fiscal future is full of doom and gloom. The national debt will double in the next 30 years to 150% of gross domestic product—which is Greece territory. Interest payments may become the largest budget line, eclipsing national defense. Federal spending is expected to soar over 20 years from 22% of GDP to 28%. Never outside of wartime has Washington’s burden been so heavy on the economy.
We pointed out, however, something that few of the budget hawks in either party had recognized. The reason the debt forecast was so grim was that its growth forecast was so slow. As we put it:
The report’s most troubling forecast, by far, is for decades of sluggish economic growth. The CBO projects that America will limp along at an average 1.9% annual growth over the next 30 years. This is a sharp downgrade from historical performance. Between 1974 and 2001, average growth was 3.3%. An extra percentage point makes a world of difference. If weak growth persists, there is almost no combination of plausible spending cuts and tax increases that will get Washington anywhere near a balanced budget.3
The article then explained the only conceivable way out of the debt trap: 3 percent growth. We showed policymakers the impact of compound interest when it comes to faster growth. By 2040, the economy would expand not to $29.9 trillion, but to $38.3 trillion, according to an analysis by Research Affiliates, a California investment firm. That’s an additional output of $8.4 trillion—roughly the entire annual production today of every state west of the Mississippi River.
By 2047, the economy would grow to $47.1 trillion, almost $13 trillion more than the CBO’s baseline estimate. That would spin off an additional $2.5 trillion each year in tax revenues—enough money to pay all the bills and cover most of the unfunded costs of Social Security and Medicare. The only time we balanced the budget in 50 years was in the late 1990s under Bill Clinton, and it was a result of very fast economic growth of 4 percent, a booming stock market, and a capital gains tax cut that opened the flood gates to added investment revenue. Now 3 percent growth was a precondition to making any progress on taming our $20 trillion national debt.
Growth of 3 percent would stop the debt-to-GDP ratio from skyrocketing with modest spending restraint. Instead it would start to fall almost immediately, eventually to about 50 percent, because the economy would be so much larger. Congress and the White House ought to understand that what matters most for heading off a fiscal crisis is making sure that the economy grows faster than the government. No other debt reduction policy—certainly not a tax increase—comes close to having the fiscal effect that sustained prosperity does.
For our strategy to work, of course, we needed to double the pace of growth from 1.5 percent under Obama’s last year to over 3 percent from 2018 to 2027. Many blue-chip economists agreed with the CBO that a growth rate of about 2 percent is the best that America can achieve because of the retirement of the baby boomers. Our belief was that there were at least 10 million Americans who could and should be working if the job market improved and they were rewarded for working by higher after-tax returns.
We reiterated at the end of the Wall Street Journal op-ed, “There’s simply no way to fix the long-term fiscal problems with 1.9% growth, no matter how sharp the budget knife. What America needs is real and sustained growth.”
Larry spearheaded on this one almost single-handedly. His mantra was that an economy growing at 3.1 percent will generate $4.5 trillion more than an economy growing at 1.8 percent.
This became the rallying cry of the White House and the GOP Congress over the course of the tax fight.
Go Big or Go Home
But how big would the tax cut be? The moderates in the Senate were still nervous about revenue losses. Senators Collins, Corker, McCain, and Flake wanted a relatively small tax cut. They wouldn’t budget one dollar over a maximum revenue loss of $1.5 trillion over ten years. This sounds like a very big number, and indeed it is. But out of $45 trillion in expected revenues over this time, it meant that the tax relief would be about three cents of every dollar of taxes—even on a static basis.
This was an improvement over “revenue neutrality.” But still, small ball. The deal with the deficit hawks came down to this: Congress would live within the $1.5 trillion debt ceiling, but we would use scoring on a “dynamic” basis, which assumes economic growth. This would give us about another $1.5 trillion of tax cuts. It was a crucial concession by the deficit hawks and a breakthrough in congressional tax scoring. We weren’t entirely satisfied. We wanted an estimate of $3 trillion more revenue from the tax cut’s dynamic effects, which we believed were fully supported by historic data. Instead we got a score of $1.5 trillion feedback. Yet this was a breakthrough. For the first time in decades, Congress would take into account the faster economic growth that tax rate reductions would generate.
We were now confronted with another challenge. Even with the dynamic scoring, we still had about $4 trillion of cuts that we needed to stuff into a $1.5 trillion box. If the score of the tax bill coming out of the CBO was one dollar over the cap, we were out of business. Finished. We had to pull off a Houdini escape-artist act to get the tax bill we wanted and still comply with the rules. Again we huddled up with congressional leaders to retain all the tax rate reductions and abide by the reconciliation rules.
In a meeting with House Ways and Means chairman Kevin Brady, we suggested a clear way out of the box. We knew that some of the provisions of the tax bill—mostly the corporate tax rate cuts and the income tax rate cuts for small business—were highly unpopular with the class warriors inside the Democratic Party. But the middle-income tax cuts—the child credit, the doubling of the standard deduction, and the cuts in the lower-income tax rates—were generally supported by Democrats. Our goal was to preserve as much of the tax bill as possible, even if Democrats were to win Congress and possibly the White House again someday.
Why not make all the tax cuts that the Democrats liked temporary, and the tax cuts that the Democrats hated permanent? We would have a five- or six-year life span for the child credits and deductions but a permanent life span for the business rate cuts.
We were fairly certain that the middle-income tax cuts would be extended in any case. What member of Congress or senator would dare let them lapse? So this was a way to preserve the heart and soul of the tax plan and create an accounting fiction that the $1.5 trillion was still being honored.
Were we being dishonest? No. Our view was that all these budget projections about what level revenue and spending would be in four, five, or ten years were complete hocus-pocus. Congress can’t even predict what the tax revenues will be one or two years into the future, let alone five or six. The ten-year forecasts are typically off by hundreds of billions of dollars. The forecasters were a gang of blind men tossing darts against a wall. And their dreadful record showed that they weren’t even hitting the wall, let alone the target!
So we had few misgivings in messing with a cracked crystal ball and no compunctions about doing so. We used the absurd static scoring of CBO and the Joint Tax Committee against them.
This was also about the time when Republicans decided to add the repeal of the Obamacare individual mandate tax penalty to the plan. This was good policy because it would free 10 million Americans from having to buy health insurance they couldn’t afford and didn’t want. But the CBO’s bizarre model forecast that the cancellation of this tax would raise some $150 billion for the government. It was the dumbest thing we had ever heard, but if that was what the referees were going to call, we’d gladly take it. Thanks, CBO!
Congressional Democrats were livid when they realized that we were bending their own rules against them. They ran to their friends and complained that the “tax cuts for the rich” were permanent and the middle-class tax cuts “go away after five years.” Our response to Schumer and Pelosi was, if you want to make the middle-class tax cuts permanent, let’s pass a bipartisan tax bill in 2018 or 2019 to do just that. You could almost see the smoke coming out of their ears. They had been outwitted.
We want to again emphasize that our goal here wasn’t to deceive the public or use phony numbers. We are well aware of the negative consequences of an ever-rising burden of deficit spending. We did find it highly ironic, however, that economists from the Obama administration—the people who doubled the national debt in just eight years—were lecturing us on fiscal responsibility. They doubled the debt . . . while raising taxes! The debt exploded under Obama for one major reason: the economy grew by about half its normal growth rate trend.
Our goal was to supercharge the economy so that the debt burden on future generations would shrink, at least in relative terms to the economy as a whole, and be much more manageable because they would inherit a more prosperous nation with more productive capacity and wealth. We also strongly favored spending reforms that would slow the stampeding growth of government, though neither party seemed much interested in that. Our point was that if government is going to keep expanding, we’d better make sure the real economy grows even faster, preventing Uncle Sam from turning into King Kong.
Now we had a big beautiful tax bill, to borrow a phrase from Trump, with almost all the pro-growth stimulants that would help make that future possible. We were ready to rock.
Laffer’s Tax Tutorial
There were still plenty of nervous Nellies in Congress who were on the tax-cutting fence. The bill was unpopular with voters and had only about a 25 percent approval rating in the fall of 2017. Democrats and the media had persuaded Americans through their public relations blitz that the Trump tax cut would raise their taxes.
The left’s propaganda machine told anyone who would listen that Republicans wanted to pass a middle-class tax hike and a giant wet kiss for the super-wealthy. And we still heard arguments from left-wing groups like the Tax Policy Center that Trump’s tax cut would blow a $6 trillion hole in the budget. If that was true, even we would have been against the bill.
It was, of course, fake news. But it was being repeated so often in the elite media echo chamber that you couldn’t really blame the voters for being misled. It was time for us to set the record straight.
It was Arthur who provided the most powerful—even devastating—technical rebuttal to the Tax Policy Center and other liberal academics and policy wonks on the budget deficit arguments. Arthur published a study in September 2017 distributed by the Committee to Unleash Prosperity that became the bible, of sorts, on Capitol Hill and inside the White House. Arthur walked through the logic of his argument in the paper and then later in a presentation to Senate Republicans during a Steering Committee lunch. His conclusion: the $6 trillion revenue loss forecast was a giant hoax that could not withstand even a moment’s serious economic scrutiny.
Arthur’s analysis showed that while some of the tax provisions, such as the doubling of the child credit, would lose money for the government for sure, the corporate tax rate of about 20 percent (which Congress was considering) would yield about the same revenue—and possibly more—than the current system with a 35 percent rate. No one could estimate precisely how much revenue feedback there would be, but we were certain that the government scoring agencies (CBO and the Joint Tax Committee) were ignoring major real-world effects of the tax cut that could add trillions of dollars of unaccounted-for revenues. Certainly the impact was not zero. When taking into account reduced tax evasion with lower tax rates, the increase in economic activity, the positive impact of state and local tax receipts, and the $1 trillion or more of repatriated capital that would return to these shores (and pay taxes), he showed that a 20 percent business tax rate could raise as much as the 35 percent rate.
The Laffer paper also cited the recent example of countries like Canada and Japan. Canada cut its highest corporate tax rate from 36 percent (2003) to 25 percent (2012), and Canada’s corporate tax revenues as a share of GDP rose from 3.15 percent to 3.29 percent respectively. Canada then reversed its corporate tax rate policy and raised the highest corporate tax rate in 2015, and tax revenues fell. Ouch!
Meanwhile, Japan cut its highest corporate tax rate from 40.9 percent in 2003 (its rate in 2003 was tied for the highest in the OECD) to 32.1 percent in 2015, and corporate tax revenues as a share of Japan’s GDP rose from 3.3 to 4.26 percent.
Arthur’s study’s conclusion is worth repeating:
Looking exclusively at corporate tax revenues and the highest corporate tax rate, the evidence is not strong but it most definitely does not support the notion that a cut in corporate tax rates leads to a decline in tax revenue. In fact, if there is an effect, it’s most likely that a drop in business tax rates increases tax revenues and a rise in such rates lowers tax revenues.
The international and historical evidence was firmly on our side that a corporate tax cut would lose far less revenue—and perhaps gain some—than critics claimed.
One convert to this way of thinking was Treasury Secretary Steven Mnuchin. We had worked with Mnuchin almost from the very beginning of our involvement in the campaign and developed a great working relationship. He was a bit new to the policy game, having come from a finance and business background. But he proved a very quick study.
He was bombarded with a lot of the same criticism that we had been fighting since day one: “There is not a shred of evidence to support the secretary’s pay-for-itself claim,” Jared Bernstein, formerly Vice President Joe Biden’s chief economist, griped. “Sure, significantly faster growth would spin off more revenues. But there’s simply no empirical linkage between tax cuts and growth that’s both a lot faster and sustained.”4
However, Mnuchin swatted away the critics masterfully. He countered that an ambitious tax cut would unleash businesses that had felt constrained by the highest corporate tax rate in the industrialized world. Corporations, he said, would be freed to build plants and create jobs in the United States instead of in foreign countries and would bring home money that currently is sheltered overseas.
“Under static scoring, there will be short-term issues,” he conceded to Congress. “Under dynamic scoring, this [the corporate tax cut] will pay for itself.” We couldn’t have said it better ourselves.
The $6 trillion revenue loss figure was officially down for the count.
Were we right? Only time will tell.
The Stupid Party Gets Smart
But we still needed concrete revenue offsets to cover the cost of the rate reductions and the child credits, as well as small business tax cuts. We wanted to broaden the tax base as much as possible and find other revenue sources to make up the difference. The Republicans have long been affectionately known as the “Stupid Party.” Waiting until mid-November to pass a must-pass tax cut would have seemed to confirm that label. But for once the pachyderms got smart.
Mitch McConnell was the first to see the opportunity that lay ahead. In the past, tax reform had been bipartisan—and in a more rational world, this bill would have been wildly bipartisan. But once Democrats declared they would be unified as obstructionists on tax reform, there was never a reason to throw even a bone to the “resistance” movement.
McConnell, one of the canniest legislative tacticians in living memory, understood that playing nice with Chuck Schumer wouldn’t buy any votes. So why bother trying?
Instead, Republicans adopted several smart pay-fors that were grounded in good economic policy while simultaneously putting the hurt to left-wing groups dependent on government largesse.
The first pay-for was the cap on the state and local tax deduction. No longer could tax filers deduct their entire state and local tax bill from their federal taxes. This was a $1 trillion pay-for in the tax bill, by far the biggest.
Left-wingers argued that this meant that states and localities were going to be victims of the Trump tax cut. In fact, states and cities were in some ways the biggest beneficiaries of this federal tax cut. When the federal government doesn’t take $2.5 trillion from the taxpayers of states, that’s $2.5 trillion that stays in the local and state economies and never has to go to Washington in the first place, as we pointed out to a large number of governors and mayors. Uncle Sam’s leaving money where it originated—and creating a climate of bottom-up economic growth—is the best thing he can do for states and cities.
The most important factor by far for state and local governments in terms of paying their bills is a strong national economy. Trump’s tax cut would help us get there. This is why more than 100 state legislators signed a letter to Congress, urging them to pass the tax cut and not flinch from capping the state and local tax deduction.
But blue states—which are more heavily taxed—would get hit harder than low-tax red states. As a matter of vote counting, the states with the highest taxes—California, New York, New Jersey, Connecticut, Illinois, and Minnesota—were states with not one single Republican United States senator.
We were strongly in favor of this policy change no matter which color states would lose the most. (Larry lives and pays taxes in Connecticut; Arthur is a tax refugee from California; and Steve long ago fled his home state of Illinois—three of the highest-tax states.) But the federal government should not be an enabler for overtaxing state and local governments and shouldn’t be bailing out bankrupt public employee pension programs. There is no possible justification for a person living in Tennessee or Utah or New Hampshire having to pay higher federal taxes to subsidize the overpriced public sectors in New Jersey and Connecticut.
That’s particularly true when one considers that there is no evidence that higher taxes in these states lead to better schools or police protection.
New York spends $7,500 per person on state and local government. New Hampshire spends less than $4,000. Yet public services are better in New Hampshire than in New York.
Liberals instantly understood some of the repercussions of this policy shift. The big blue states either must cut their costs, and taxes, or the exodus of high-income residents from these states will accelerate. We have estimated that unless New York, California, New Jersey, and Minnesota cut their state and local income tax rates—of 10 percent or more—they will lose about 3 million residents—most likely their biggest taxpayers—to other states in the next four years. This could put a big revenue hole in these state budgets. California and New York already lost a net 2.5 million residents to other states from 2007 to 2016.
This cap also ironically made the Trump tax cut more progressive. The $10,000 cap on the state and local deduction meant that about 90 percent of tax filers would be unaffected. The people who would be hurt by this provision were very wealthy tax filers in high-income-tax-rate states.
Here were left-leaners like Governor Andrew Cuomo of New York defending a $1.5 trillion tax loophole for the richest 1 percent whom they elsewhere rhetorically flog.
So this is what hypocrisy looks like.
Next was the gutsy decision by Republicans (and mentioned above) to offset the cost of the tax cut by eliminating the individual mandate tax imposed mostly on Americans who earn less than $50,000 a year. This was a tax primarily on poor people whom Democrats claim to want to protect. The purpose of the tax was to induce Americans to purchase health insurance. We found it amazing that Obamacare subsidizes people to buy health insurance, penalizes them if they don’t, and yet at least 13 million Americans still refused to buy it. That would seem to be the sign of an inferior product.
Finally, an idea that didn’t get much attention is the tax on college endowments. These are massive storehouses of wealth. Harvard and Yale combined sit on roughly $20 billion. This is enough to give every student free tuition at these schools from now until forever . . . and the colleges would never run out of money. Instead these university endowments are like giant tax-exempt hedge funds with very little largesse going to help students pay their exorbitant tuition and room and board.
The GOP plan placed a small 1.4% tax on endowment net investment income for schools with more than 500 students and at least $500,000 of investments per student. Our complaint here was that by our calculations, the tax rate was way too low. But, nevertheless, the first shot across the bow of the university-industrial complex was fired.
Will this hurt education? Professor Richard Vedder of Ohio University, an expert on higher education, has documented that university tuitions don’t go down when these schools have bigger endowments. They go up.5
Perhaps our favorite bonus provision added to the tax bill was allowing drilling for oil in Alaska’s Arctic National Wildlife Refuge. This was something that sensible people had advocated for since the mid-1980s. We agreed with Trump that this would create jobs, help resuscitate Alaska’s economy, and make America more prosperous by adding 10 million barrels of oil production a year. Bonus: it will also bring in additional federal revenues, as the energy companies that will drill there will pay federal income and payroll taxes, as will their employees, plus corporate taxes and royalties.
It was a major win-win for the economy. The objections of environmental extremists were overstated and unpersuasive. The area of drilling would be equivalent to a medium pizza on a football field. We had learned from the building of the Alaska pipeline in the mid-1970s that the environmental effects were greatly exaggerated. Economic development and environmental protection can, and must, peacefully coexist.
Even better was that the Alaska drilling was the one demand that Senator Lisa Murkowski had made in exchange for her vote. Senator Murkowski had voted against the Obamacare repeal bill three months before. Thus, her vote on the tax cut that included repeal of the individual mandate was very much a concern for Republicans, who had to get 50 yeses out of 52 Republican senators to enact this legislation.
All these changes created a consortium of special-interest lobbies that hated the tax bill. These included health insurance companies, green groups, Obamacare supporters, public employee unions, state and local officials, the welfare lobby, municipal bond traders, sociology professors, corporate lobbyists, and, most of all, left-leaning politicians. In short, those who protested were those who are funded by the loopholes eliminated.
Bravo, Trump! It doesn’t get any better than this. What better way to drain the swamp?
The Problem with Delaying the Tax Cuts
A pivotal moment in the tax cut battle came on November 9 when Senate Finance Committee chairman Orrin Hatch released the Senate markup of the bill. This was a very good bill. It was actually better than the House bill—an unexpected accomplishment. Usually the Senate waters down the House’s bills, but in this case, Chairman Hatch and Senator Pat Toomey of Pennsylvania, his lieutenant on the tax bill, added more growth tonic.
The Hatch tax bill also had lower income tax rates and most of the other features of the House bill—and was superior in certain ways to the House bill.
One feature that gave Arthur heartburn, though, was a provision to delay the corporate tax cut for one year, so that it would begin in 2019, not 2018. This was to save money. The Senate was up against the $1.5 trillion budget resolution hard cap on the ten-year size of the tax cut. Hatch couldn’t get the rate down to 20 percent unless the tax cuts were delayed until 2019.
The proponents of this policy argued that the capital expensing provision (100 percent depreciation in one year that was scheduled to take effect on January 1, 2018, and last for five years) would offset the one-year delay in cutting the corporate tax rate. Here’s Speaker Paul Ryan on the issue: “Phasing in [sic] the corporate reduction still is very good for economic growth. . . . You still get very fast economic growth and you actually are encouraging companies to spend on factories and plants and equipment and hiring people sooner with the phase in.”
At a meeting with some 30 Senate Republicans, Arthur insisted that the logic here was completely wrong. If they delayed the tax cut, it would hurt the economy and harm the GOP in the 2018 midterm elections. “If the tax bill is proposed and signed into law,” he explained, “then the current statutory maximum corporate tax rate and current depreciation schedule are no longer relevant. You would instead ask yourself the following question: which would I rather have, A) 100 percent expensing and a 35 percent corporate tax rate or B) 100 percent expensing and a 20 percent corporate tax rate? If B is your answer, which it should be, then you will postpone your actions until the second year, 2019. The choice between A and B is the correct choice businesses will face if Congress passes the bill with a delay of the corporate tax rate cut.”
Then Arthur asked the senators: “What option would you choose?”
He also gave the senators a valuable economic history seminar.
In 1981 when President Reagan’s tax bill passed, the president gave me a congratulatory call, yet he sensed early in the conversation that I was not as excited as he thought I should be. He was incredibly excited about getting the tax bill through—and I was too—yet I was concerned about the effect of phasing in the tax cuts. I asked him, “How much would you shop at a store a week before that store has its big discount sale?” He saw the point immediately.
History demonstrates that broadcasting a delay in a tax rate cut corresponds to a delay in economic activity until the new lower tax rates are fully phased in. Arthur had lived through the delaying of the 1981 income tax cuts, which were not fully phased in until 1983. He contends this made the 1982 recession much deeper than it might have been had the cuts been effective immediately. He said the phase-in mistake delayed the Reagan expansion by about 18 months. Don’t repeat that mistake, he pleaded.
In the end, Arthur carried the day. None of the senators, especially the ones who were up for reelection in November 2018, said they would support the tax cut delay. That was the end of that.
The GOP senators compromised with a 21 percent corporate tax rate—one percentage point higher than the 20 percent reported out of the House—but effective immediately on January 1, 2018.
Don’t Forget Small Businesses
Throughout the debate, we never forgot the Trump demand that the tens of millions of small businesses needed to get a tax cut too. It turns out that as the plan got negotiated in the House and Senate, small businesses were getting a tiny tax cut while corporations got a sizable rate cut.
That wasn’t fair, and one senator who took a stand for this this was Senator Ron Johnson of Wisconsin. In early December, as the bill was headed for the Senate for a final vote, Johnson told the media he was a “no” on the tax bill. This news sent shock waves through the Capitol. “If Congress wants to pass a tax bill that doesn’t help small businesses, they will have to do it without my vote,” he announced.
Senator McConnell and his staff asked us to see what we could do to pull Johnson back into the fold. We had worked with him from the time he had first run for Senate in Wisconsin back in 2010. One thing was for sure. Without Ron Johnson’s aye there would be no tax bill.
We visited Johnson the day after we visited two other last-minute dissenters, Steve Daines and Bob Corker. Johnson, one of the few actual small business owners in the United States Senate, was as angry as a Wisconsin badger when we came into his office. He growled at us that the tax bill as passed through the Senate was false advertising. “There is no tax cut for many of the millions of small businesses,” he protested. He walked us through the reams of analysis he had done, and . . . his proof was irrefutable. The bill was offering crumbs for small businesses, and this was a bait and switch.
We vowed to work with Johnson to fix this. Johnson wanted two things. A lower top income tax rate of 37 percent, down from nearly 40 percent under the current code. Since about two-thirds of the folks in this income tax bracket are small businessmen and -women, this made sense. He also wanted a 20 percent exemption on small business income from federal tax. We liked that idea too. This would bring the top small business tax rate down to an effective rate of about 30 percent for most successful small businesses, down from nearly 40 percent under current law.
The White House was fully in support. We reminded President Trump that he had always told us from the start he wanted a low tax rate on the small businesses of America and that the Johnson amendment would deliver on that promise. It would also create a rough parity for large corporations and small businesses. When taking into account the double tax on corporate dividends and capital gains, all business profits would be subject to roughly a 30 percent tax rate.
We went back to Senator Johnson and laid it out for him. He was a happy camper. The Trump tax cut would be the biggest small business tax cut in at least 15 years.
Liberals uttered a primal scream about the 37 percent tax rate. Tax cuts for millionaires! they shrieked. But they seemed to forget that in the United States, small businesses pay their income tax on the individual income tax return of the owner, not through the corporate tax system. They couldn’t seem to understand the basic truism that a very high top income tax rate of 39.6 percent was nearly the highest in the world on small businesses, and thus hurts small and medium-sized firms. Without these companies prospering and expanding, where were the new jobs going to come from? We liked to quote from the former House majority leader Dick Armey: “Liberals love jobs, but they hate employers. You can’t have one without the other.”
We were disappointed that professional-service small businesses such as accounting, financial, and communication firms were precluded from accessing the lower rate. While we agreed that the optics of a hedge fund paying a lower tax rate than a wage earner in the heartland would be bad, we wanted to see this lower rate extended to all small businesses that are also employers, regardless of industry classification, in order to do the most good for employees, job seekers, and the overall economy.
We routinely talk to men and women who own and operate small businesses. Most of them told us that if Congress delivered on the Trump tax cut, they would invest most of their tax savings into growing their businesses so they could become medium and even large businesses over time. This is what happened in the immediate aftermath of the tax bill.
This is how President Trump will create the next generation of Home Depots, Costcos, and FedExes.
Stop the Stealth Capital Gains Tax Hike
Another brushfire we helped snuff out could have burned down the bill. No one knows quite how it happened—which says a lot about how the sausage-making factory works on Capitol Hill—but someone, probably a committee staffer, slipped into the Senate bill a stealth capital gains tax increase on long-held assets. When we learned about this after reading through the bill, we rang the alarm bell and were surprised to discover most members of Congress had no idea that this booby trap was buried in the bill.
The provision turned the capital gains tax on its head by requiring shareholders to sell their oldest shares of stock in a company before their newest purchased shares. The older the share, typically, the larger the taxable capital gain. This is called the first-in, first-out (FIFO) accounting system.
Consider this example. Let us say you bought 100 shares of Apple stock in 1998 at $100 a share. And let’s say you bought another 100 shares in 2008 at $300. If you sold 100 shares at $500 a share, you would have to “sell” the oldest stock and pay a capital gains tax on the $400 difference between the price you bought it for and what you sold it for. Under the current law you could sell the shares you bought for $300, realizing a capital gain of only $200. Now, this accounting change to FIFO might make sense in some circumstances . . . except that the gains on stocks are not adjusted for inflation. On many sales of long-held stock, as much as half of the reported and taxable “gain” is due to the increase in price, but not value, attributable to inflation.
This sneaky booby trap would have meant that the actual capital gains tax incurred upon sale could more than double the tax due for many stock and asset sales.
So the Senate rules would have required millions of Americans to pay a stiff tax on phantom gains. That is patently unfair, and we told the congressional leadership this would discourage the very long-term investment the bill was intended to stimulate.
Under the Senate bill, there was also an exception for mutual funds, exchange-traded funds (ETFs), and other institutional funds. They would continue to apply the current law tax treatment.
So get this: the regular Joes and Jills who want to buy and sell stock on their own would have to pay the higher capital gains tax. The big investment funds were being provided a more generous set of rules with lower taxes. Good news for Fidelity and Vanguard. But what about Joe and Jill Lunch Bucket? Forced FIFO would have pressured small investors to purchase stock through the big fund managers—and pay their fees. This is, of course, antithetical to President Trump’s populism, his commitment to having regular people—his base—get a fair shake. It was an alarming provision.
In addition to the fairness factor, the higher tax on capital gains would have discouraged people from buying stock, or investing, in small start-ups in the first place. This provision would have also exacerbated the lock-in effect of the capital gains tax. When the tax on gains is higher, Americans are much more reluctant to sell their shares and pay the higher tax.
This benefits old established companies like Boeing and Microsoft. It dries up capital for smaller and fast-growing firms that could become the next generation’s Apple, Google, or Uber.
But Ways and Means Committee chairman Kevin Brady saved the day! We contacted the chairman, and he and Speaker Ryan sprang into action, alerting the Senate that no bill would be approved in the House booby-trapped with such an unintended capital gains tax hike. Were we lucky or smart to have tripped across this subtle booby trap? The offending provision was stricken from the bill.
Fifty Is Nifty
There are only 52 Republicans in the Senate. President Trump needed 50 + 1 votes to win. We lost a lot of sleep in those last few weeks over the possibility that we would come up one or two votes short. This is exactly what had tripped up Obamacare’s repeal and replace. On the final vote, John McCain, who was undergoing treatment for brain cancer, opted to vote against Obamacare repeal. Obamacare, with all its egregious flaws, survived.
We just couldn’t have it on our conscience that we allowed a defeat of the president’s signature initiative—the tax cut. Too much was at stake. The importance of this legislation transcended that of mere politics.
One of the factors that helped get 50 + 1 votes in the Senate was the severe negative political consequences of losing. Nearly every Republican over the summer recess had been pilloried by conservative voters for failing to deliver on repealing and replacing Obamacare. This reinforced the sense that failure was not an option on the signature GOP issue—the big tax cut. The Congress, both House and Senate, was looking at an electoral wipeout in November 2018 if Capitol Hill failed to deliver a major, historic tax cut.
The three of us made the case—over and over—that the powerful economic burst of adrenaline since Trump’s election, and the surge in business and consumer confidence, would reverse course if the Congress failed to deliver the promised tax cut. The main thing the GOP had going for it at this stage was the good feelings voters had about jobs and growth prospects. Optimism abounded.
We reminded Congress at every turn that passing the tax cut would support a big stock market rally, promoting the happiness of their voters, and that stalling out on the tax cut would certainly prompt a bearish market sell-off, to their detriment. The likelihood of a market panic—and an economic contraction—buttressed wavering Republicans to support the tax cut.
Finally, we made the case that the tax cut had to be passed before Christmas. If the bill was unfinished heading into 2018, there was a good chance it would not happen. Republicans had lost the special election in Alabama—of all states—when voters ruled Judge Roy Moore unfit for office. The GOP would have a Senate majority of only one vote in 2018.
The window in which to pass the Trump tax cut was slamming shut fast. We felt like Harrison Ford as Indiana Jones trying to outrace that massive boulder rolling toward him down the hill. Hurry!
This created a mad scramble to get the tax cut passed, in December, and in less than three weeks. It was a daunting challenge, but not impossible.
We worked closely in the final weeks with Brendan Dunn—McConnell’s policy director, who was in charge of counting the votes and making sure Republican support didn’t falter on the eve of President Trump’s historic tax cut.
One of the darkest days was in early December. Leader McConnell updated us on the status of the pending Trump tax cut. “We have big problems on our side of the aisle,” he wrote. “We don’t have the votes right now.”
Leader McConnell gave us the names of the key Senate stragglers. Our mission now was clear. The list included John McCain, Bob Corker, Ron Johnson, Steve Daines, Jeff Flake, and Susan Collins.
Each had different reservations about the bill. Some thought it cut taxes too much. Others said it cut taxes too little. The week before Christmas Larry, Steve, and Arthur met separately with each of these senators, in some cases several times.
Larry flew to D.C. on December 18 and spent the entire day scrambling with Steve from one office to the next in a last-ditch effort to make the case, cajole, and, as a last resort, twist off arms if necessary.
Larry was recovering from dental surgery the day before, but he still rose to the occasion. When Steve met up with him in front of the Hart Senate Office Building that morning, Larry looked like he had been clocked with a Joe Frazier left hook. His jaw was the pink color of watermelon and he was moaning and slightly slurring his words.
We wondered whether he would make it through the day . . . stacked as it was with one-on-one meetings with United States senators. Talk about taking one for the team! But we really felt this was about changing the direction of the American economy for a decade. That’s how big the stakes were.
Larry and Steve sat with the undecided senators. (Arthur had been on Capitol Hill a few days before . . . doing the same rounds and making the economic case to turn around the no votes.) Larry and Steve were the ninth-inning relievers. We didn’t do the hard sell. We patiently walked through the virtues of the Trump tax cut with many wavering senators.
All the senators—so it seemed to us—wanted to vote for the Trump tax cut. None of them wanted to go down in history as casting the vote to kill Trump’s tax cut.
That said, getting all of them to vote yes was a heavy lift.
The bill had been pummeled by the media and their enablers, the plethora of left-wing special-interest groups. Before the vote, fewer than one in four voters supported the bill. Millions of Americans thought it was a tax increase, because that was the fake news delivered through much of the elite media.
Fortunately, we knew the features of the tax plan intimately. We had the facts on our side. We knew also that about 90 percent of middle-income voters would pay less, not more, in federal income taxes.
Our line to the senators was that once the public sees the tax cut—and extra take-home pay in their fatter paychecks—they would figure out that the media, Chuck Schumer, and Nancy Pelosi had been lying to them. They would see the proof in their paychecks.
That was our calculus.
The two Republicans we were worried most about were Bob Corker and Susan Collins. We knew that if we could earn their votes, the Trump tax cut would pass.
Both had principled objections to the bill, and we respected that. They were both worried about the deficit impact, and Collins worried about the impact of Medicaid payments to her state of Maine. Corker was the senator who insisted that the price of the tax bill not exceed $1.5 trillion over a decade—out of about $45 trillion in expected revenue collections. He demanded assurances that we weren’t violating that promise. He was skeptical that the growth dynamic we were predicting would happen.
We explained that the additional growth from passage of the bill would significantly reduce the fear of a budget deficit. What we repeated, over and over, was that we could expect $3 trillion more revenue from 1 percent faster growth. The CBO confirmed this relationship. We needed to “grow the denominator” (and shrink the numerator) of the debt-to-GDP ratio or else our fiscal future would get worse, not better. That was the only way out.
Some of these Republicans had bought into the “limits to growth” narrative of the left—that the economy has a ceiling of 2 percent annual real growth. This is America. Don’t buy the pessimism, Senator.
And as a purely political matter, we reminded these crucial U.S. senators that Trump and the Republicans won the election by promising jobs and prosperity. A majority of voters agreed with Trump that a tax cut would be good for the economy. Failure to get a pro-growth tax cut done would imperil nearly every GOP seat. Conservative voters weren’t going to buy into the lame excuse that “the CBO wouldn’t let us do it.”
At the end of those meetings, both Senator Corker and Senator Collins sat back and almost sighed in relief, half whispering, “OK, I’m a yes on the president’s tax cut.” We knew at that magical moment we had it.
On December 18 the two senators on the fence made their public declarations that they would vote for the Trump tax cut the next day. It was one of the happiest days of our professional lives. This bill would be the most pro-growth tax bill since Reagan. It would change the country.
President Trump would make history.
Postscript
A few months after the tax cut passed, Steve met up with President Trump at his winter retreat, Mar-a-Lago in Palm Beach, Florida. Trump was eating dinner, and Steve had been invited as one of the guests for a reception there that night. At dinner, Steve ambled over to the table where Trump and first lady Melania were seated. Steve walked past the Secret Service agent and tapped the president on the shoulder when he wasn’t in conversation. He turned around, jumped out of his chair, and jubilantly spurted out: “Steve, isn’t this the greatest tax cut ever? Can you believe the impact this is having? All the jobs. All the bonuses.” He was referring to the 5-million-plus workers—mostly low- and middle-income Americans—who had already received bonuses and pay raises in the aftermath of the new tax law. The unemployment rate had neared a 30-year low just weeks before.
Steve replied, “Mr. President, it’s working out better than when we drew it up on the chalkboard two years ago in your office in Manhattan.” Trump nodded his head yes and replied with a big smile: “It really is, isn’t it?”