GOP Tax Plan Will Stunt Innovation in Its Infancy

Jonathan Gruber (MIT) and Simon Johnson (PIIE)

December 1, 2017
Photo Credit: 
REUTERS/Aaron P. Bernstein

President Trump and Republican congressional leaders claim their current tax proposals will accelerate economic growth and create more good jobs. Actually, both the recently passed House bill and the current draft Senate legislation would depress our potential growth rate.

The fundamental determinant of our standard of living as a society is productivity growth, and the main long-run driver of productivity growth is the creation of new knowledge.

Discovery of new ideas, and the private sector application to commercial products, has long fueled growth in the United States—and made our universities and tech companies the most admired in the world.

To spur growth, we should focus on accelerating knowledge creation and entrepreneurship. But this legislation heads in exactly the opposite direction.

This is clearest in the fact that both House and Senate plans would severely limit the ability of companies to deduct research and development spending from their taxes. Currently, corporations can deduct those R&D expenditures as they occur, as with other corporate expenditures like advertising.

Under the proposed legislation, the deductions would be spread over five years (see Section 3315 of the House bill), meaning that they are typically worth less to the companies. This increases the post-tax cost of invention and reduces the incentive to do research and develop new products relative to spending money on other activities.

Why would we want to make it more advantageous for a company to run an ad than to research a new product? According to Rick Lazio, a former Republican congressman who now works with a tax advisory firm, the chilling effect may be particularly significant for smaller businesses.

But the anti-knowledge and anti-growth bent of the pending legislation goes much deeper. Both the House and Senate plans would also tax the endowments of large universities. Most large research universities lose money per student; the cost of educating students exceeds the tuition that they pay.

This is particularly true for graduate students. University endowment income is therefore a critical source of support for universities to pursue their educational and research mission, and universities operate free of tax because they fulfill this important social purpose. Taxing endowment income will lower the ability of universities to generate knowledge.

Moreover, this change will deter giving to universities. Who wants to give to a taxable university when they can give to a tax-free hospital, food bank, or opera?

The House and Senate proposals each also include other provisions that discourage knowledge-accumulation and growth. The House plan treats graduate student tuition grants as taxable income. Graduate school, like other professional schools, is expensive, yet expected incomes are much lower if you get a PhD in biology rather than a MBA, MD, or JD.

To offset this, most universities subsidize the tuition costs for graduate students so that they can pursue these degrees to promote knowledge—often as part of broader scientific research efforts. Taxing these benefits would make graduate school unaffordable or unappealing, even for potential young Nobel Prize winners.

Meanwhile, the Senate bill repeals the individual health insurance mandate. This will serve to partially destabilize individual insurance markets, raising premiums for millions. Why does this impact knowledge and growth? Because a major barrier to knowledge accumulation and risk taking in the labor market is fear of losing health insurance.

Individuals who have health insurance on their job will likely be less willing to leave that job to attain more education or to start a new business.

The Affordable Care Act addressed this concern by providing exchanges where affordable insurance made those types of dreams a reality. Removing the mandate would make insurance harder to afford for individuals and make them less willing to move into knowledge accumulation and risk taking.

Last, but definitely not least, both the House and the Senate plans would deter growth through expanding the federal deficit and greatly increasing our national debt. A key factor for long-run growth is total national savings available for productive investment.

A larger budget deficit, all other things equal, means more of our savings used to finance current government spending—and less available for investment.

The Trump administration responds that their full tax cut package will stimulate enough growth to reduce national debt relative to the size of the economy. But all the credible analysis—including from the Joint Committee on Taxation and the Congressional Budget Office—indicates that this simply will not happen.

The proposed tax legislation will be good for people who are already rich, like Mr. Trump and most of his cabinet. But it will be bad for growth, bad for people who would otherwise create the knowledge that makes us all better off, and bad for all future generations of Americans.

Jonathan Gruber and Simon Johnson are professors at MIT, in the Department of Economics and the Sloan School of Management, respectively. Johnson is senior fellow at the Peterson Institute for International Economics. Follow him on Twitter at @baselinescene.