Mr. Trump’s proposed plan includes slashing the U.S. federal corporate tax rate to 15 per cent from its current 35 per cent.BRENDAN SMIALOWSKI/AFP / Getty Images
Donald Trump's new plan for deep cuts to corporate taxes might look like a naively simplistic conservative-populist gesture that fails to address some pretty basic fiscal and economic questions. And, in some ways, it is.
But at its root, it's not much different from the Canadian model of the past two decades. And the most elegant solution to closing the fiscal gap created by Mr. Trump's plan might also be a Canadian one: Something like a Goods and Services Tax.
Mr. Trump's proposed plan, formally unveiled Wednesday after much anticipation, calls for (among other things) slashing the U.S. federal corporate tax rate to 15 per cent from its current 35 per cent. The Trump administration is convinced that the cuts (as well as personal tax reductions) will spur massive job creation and economic growth. Critics worry the plan will send the government, already running an annual deficit of approximately $500-billion (U.S.), on a course for fiscal disaster.
Some proponents are certain to defend the fiscal logic of the tax cut with the Laffer Curve. It's an economic theory, generally supported by economic evidence, that states (in part) that when taxes are reduced from high rates, it provides an incentive for companies and workers to produce things. That generates a bigger base of taxable income, allowing for total tax revenues to be maintained despite the lower rate.
But like any curve, it has a peak: an optimal corporate rate at which tax revenues are maximized; cut beyond that, and the additional taxable output isn't enough to make up for the tax-rate reduction. While attempts to analyze that peak are far from precise, economists generally guess it's in the ballpark of 25 per cent; it seems all but certain that slashing the corporate tax rate to 15 per cent would leave a big hole in Washington's budget.
There's also the matter that Mr. Trump is proposing this massive fiscal stimulus at a time when the U.S. economy is already running at a relatively brisk pace and its labour market is already very near full employment, if it's not already there. The capacity for big additional growth gains is limited. And indeed, with the economy already approaching full speed, any additional juice it does get from tax cuts would only prompt the Federal Reserve to accelerate the pace of its interest-rate increases to keep the economy from overheating, thus leaning against the stimulative impact of the tax package.
So the notion that the tax cuts would basically pay for themselves, through growth, looks deeply flawed. Unless Mr. Trump is prepared to send his government down the road to fiscal Armageddon – or, perhaps more pressingly, trigger a revolt among the staunch fiscal conservatives who dominate his own Republican Party in Congress – Mr. Trump needs to address the other side of the budget equation.
He could do that by embracing a second pillar of Canadian tax policy: A value-added tax that might end up looking a lot like the GST.
Canada's own rationale in 1991 for creating the GST was not wildly different from what Mr. Trump is talking about today. The GST was pitched by the Progressive Conservative government of Brian Mulroney as a superior replacement for a large tax that hit goods-producing companies – the 13.5-per-cent manufacturers' sales tax – which, the government argued, made Canadian manufacturers uncompetitive in export markets. The tax was, at least initially, largely revenue-neutral, but it shifted the burden of the taxation away from producers and toward consumers.
"The existing tax destroys jobs. It makes our exports less competitive and favours imports over Canadian-made products," former finance minister Michael Wilson said in his budget speech announcing the replacement of the manufacturers' sales tax with the GST – lines that, with a little editing, could have been spoken by Trump administration officials today.
Since 2000, with the GST to lean on, Canada's federal government has cut its net general corporate tax rate nine times, reducing it by almost half, from 28 per cent to 15 per cent. Today, Ottawa collects almost as much in GST each year as it does in corporate taxes.
The GST happens to share some key similarities with the border-adjustment tax that Congressional Republicans have proposed – something that was long expected to be a key part of Republican tax reform, although Mr. Trump's people said flatly Wednesday that it is not part of their plan. Both act as a value-added tax (VAT) at the border, which Congressional leaders, and even some of Mr. Trump's advisers, are keen on. Value-added taxes are ultimately paid by the end consumer, so they are applied to imported goods when they enter the country, but not on exported goods that are consumed elsewhere.
The big difference is that value-added taxes such as the GST are also applied to all domestic goods sold at home, and thus would effectively be a new U.S. federal sales tax – something that might be a tough sell to voters.
But a value-added tax would address Congressional Republicans' concerns about levelling the playing field with the many U.S. trading partners (including both Canada and Mexico) that impose a VAT on imports, without many of the associated trade distortions or baldly protectionist overtones that accompany the existing U.S. border-adjustment proposals. And it would provide a meaningful revenue stream to offset the impact of the corporate tax cuts – something Mr. Trump will need, both politically and practically, to make his tax cuts fly.
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