How Trump’s tax policy will influence income inequality in the USA.

Trump’s Tax Plan

The recent elections in the United States have received a lot of attention worldwide. The fact that Donald John Trump (hereafter Trump) won the elections came as quite a shock to a lot of people. Opponents of Trump have criticized his plans for the future heavily, including his tax plan. During the elections Trump promised to drastically change the tax system in the US seen as he was not a fan of the current tax regime. He even blamed the tax laws that it was possible for him to manipulate the laws by having to pay so little taxes due to earlier losses he experienced (seen as the tax rules state that if a company loses $100,000 in one year, they do not have to pay tax over $100,000 the next year).

According to Trump’s Campaign his goals were “to provide tax relief for the middle class, simplify the tax code, and increase the American economy, without adding to the debt or deficit”. To achieve these goals he will change several things regarding the tax system.The major aspects of his plan are cutting individual tax, cutting business tax, imposing a tax on overseas profits of companies that are based in the US, and getting rid of the death tax. For now we are most interested in seeing what these tax plans will do to the income distribution in the US. Seen as a major part of the income distribution depends on individual income we will mostly focus on the individual income taxes.

Individual Income Tax changes

There are a few things concerning the individual income tax that Trump is planning on changing. Firstly, he wants to cut back the tax system to having only three tax brackets. The current system consists of seven different tax brackets which you can see below.
tax-us

When we compare the current system to Trump’s tax proposal (see below) there are a few noticeable differences. First of all, you can notice the simplicity of his system by having only three tax brackets. Secondly, we can see that most income groups will benefit from the new tax regime, except for the lowest income group which used to pay 10%, and the middle class that used to pay 28%.Under Trump’s regime the lowest income group will have to pay 12% tax instead of 10%, and part of the middle class that earns between $112,500 and $190,150 (single filers) used to pay 28% tax and will now be charged 33%. tax-trumpThe Guardian says about 8.5 million families (and especially single parents) will experience an increase in taxes. At the same time America’s richest 1% will collect 47% of all tax cuts and experience a tax cut averaging $214,000 per year. These facts show us that most of the benefits will go to the highest income groups while the lowest income group will not benefit from Trump’s tax regime. Besides this, not all middle class incomes will benefit (the 28%) from such a tax change. While people have been praising Trump for keeping his promises (e.g. the temporarily travel ban on seven Muslim-nations), it seems to be the case that also Trump, just like the typical politician, is not keeping his promises. As mentioned earlier, one of his goals for the new tax regime was to provide tax relief for the middle class. Seen as part of the 28% group will not benefit from his tax plan, this goal will not be achieved.  

By the facts given above, one can see that Trump’s tax regime is likely to increase the income distribution even further in the US. However, in the Guardian Trump says the benefits the richest income groups will experience will pay itself back through increased investments, triggered transactions, more jobs, and more economic growth. Seen as we unfortunately cannot predict the future, we do not know if the benefits to the richest Americans will indeed be beneficial to society. We do know that the above mentioned benefits will only apply when the interest rate stays the same. As the Tax Policy Center mentions, the interest rate likely will not stay the same seen as the government’s tax income decreases due to the lower taxes. Therefore increased government borrowing will increase the interest rates and thereby decrease private investments. In such a case a not so unlikely scenario is that people could decide to increase their savings instead of consuming or investing more. Next to this, the lowest income group will even decrease their consumption further seen as they will have less money to spend. This decrease in consumption plus the interest rate which will likely increase, has led us to believe that Trump’s tax regime will contribute to an even larger income distribution. However, what should be noted here is that this conclusion is purely based on the changes in income distribution. To get a better understanding of the possible results, a lot of things should be taken into account. For example the corporate income tax which Trump is planning on decreasing from 35% to 15%. This allows companies to keep a bigger portion of their profits, which can increase growth and investments, attract foreign companies to invest in the US, and create new jobs. These benefits could outweigh the disadvantages of decreased consumption and increased interest rates mentioned before. To see whether the advantages or disadvantages of Trump’s new plans prevail, further research is required.

Income distribution in the US

The concern regarding Trump’s plan however remains how much the gap between poor and rich will expand. OECD Data from 2013 has shown that the US is ranked second in the world list of income inequality, and the new tax policy of Trump doesn’t seem to improve this. But what are the consequences of inequality? Inequality can have many different effects hence there is no clear answer on what the consequences would be for the US. Some argue that inequality contributes to economic growth, or they consider it as a necessary part of a social progress. Others argue that it would hinder economic growth, exploit disadvantaged populations and lead to social problems.

Economists have given the following reasons for the existence of (increasing) income inequality: globalization, technology, and government decisions. Despite the fact that the majority of economists agree on these influential factors, they cannot agree upon a solution. One group argues that the poor should be helped without pulling the rich down, while the others consider that this is not possible without making sacrifices.

In the US, income inequality has not always been a huge problem like nowadays. During the 70s the wealthy top 1% took only 10% of US total income. Over the past few years it has increased to 20% of US total income. For the lower 50% of the US population, the change inscreen-shot-2017-02-16-at-16-06-55 income was less bright. In the 70s they earned about 20% of total income, while nowadays they barely earn 12%. The graph on the left clearly shows how the richest 1% became even more wealthy at the expense of the lower 50% of the population. With Trump’s proposed tax cuts the income between the lower 50% and the top 1% will probably only get even bigger.

screen-shot-2017-02-16-at-19-44-40In addition it has also been studied what the effects on income distribution would have been if the distribution remained the same as it was in 1979. The results of this research are quite impressive; Families in the bottom 80% of the income distribution would be making an average of $11,000 more a year, than they are earning today. Families in the top 1% would be making $750,000 less than they do now. In contrast to the current situation, the middle class would have experienced the biggest gain. Logically this implies that the middle class is now making biggest loss since 1979, and therefore it could be the case that they again will be hit the hardest.

However, this is not the only reason that the middle class will probably be hit the hardest. Other important factors are the large expenditure increases for higher education, health care and rent, while income remains stable. This is also called the middle class squeeze. The fact that Trump also plans to cut health coverage will even worsen their position further. Families will therefore depend more on social security, which will be challenged under Trump.

Trump vs. Hillary

During the elections Hillary also came up with several tax proposals. Although these proposals did vary a bit, they all had one thing in common; ensuring that the wealthy Americans would pay more income tax. Clinton’s tax plan therefore differed a lot from Trump’s plan. The Guardian published one of her tax plans which proposed that the richest 1% of the population would pay an extra $163,000 a year on average. This would increase the government’s tax revenue and likely decrease income distribution slightly. So it seems to be the case that Clinton’s plan would be a better fit whilst looking at the income distribution. So did the US make a mistake by electing Trump as their president? When we look at all the media attention and criticism that was given to Trump being elected, a majority of the countries outside of the US would probably answer this question with a big YES. Hillary supporters will agree with this answer, but only the future will tell whether the Trump supporters will regret voting for him. For now we can only wait and see what the outcome of his (tax) plans will be, and hope that the outcome on the income distribution will be better than we expect it to be.

 

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