INTERVIEW: Kyle Pomerleau

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Kyle Pomerleau is a federal tax expert and senior fellow at the American Enterprise Institute. He previously was chief economist and vice president of economic analysis at the Tax Foundation. We spoke on November 18.

I wanted to talk about the tariffs, and how that ties into other corporate and international tax issues. I think one of the big questions that's on everyone's mind is, how serious is Trump about this, and how would he approach it? And how would the Republicans in general approach it? This idea of not only having many more tariffs, but even a universal tariff, and using that as a budget revenue source.

First, I think incoming President Trump is serious about broad tariffs, whether those are on specific countries, like the 60% tariff on Chinese imports proposal, or the across-the-board tariff proposals that range from 10% to 20%. We know that Trump, in his previous administration, enacted significant tariffs on specific products and specific countries. This time around, he has promised to do even more than that. As a legal matter, he has brought authority to enact these tariffs. It's not just the case that he has the authority to do individual tariffs on steel for national security purposes, but there is legal precedent that allows him to do broad tariffs that may be across-the-board on all imports. In the past, similar legal authority has been used, for example, by President Richard Nixon, to enact across-the-board 10% tariffs on imports, and the only institution out there that really could stop him is Congress. So I'd say that there's a good chance that he enacts tariffs.

Now, we know that his administration has not always all been totally on the same page. Sometimes certain members of the administration are more skeptical than he is about certain policies, and it may limit the amount of tariffs he ultimately does. But the authority is there.

Then there's the issue of how tariffs are going to interact with the coming tax debate. Tariffs have been put forth as a possible payfor for extending the Tax Cuts and Jobs Act individual provisions, which are going to expire at the end of next year. Those provisions are going to cost quite a lot, so they're going to be looking for ways to reduce that cost, and they may look outside the individual income tax, and one place to look would be those tariffs. We'll probably get into more of the details here, but it matters whether the Trump administration enacts them, or if Congress actually incorporates them into a bill and enacts them itself. There's other budgetary reasons why they probably want to do the latter and not the forward.

That was going to be my next question, but there's a lot to think about there. So you think he really could do all of his plans just through executive action? I know that [Section] 301 is supposed to be somewhat more particular, in theory.

301 in particular is more targeted, but there are other sources of legal authority that he has, that could allow him to do broader tariffs. And a lot of these authorities require him to declare some sort of national emergency or national security purpose. But at the end of the day, it's the administration that is determining the justification. So there's not much there to stop him.

One interesting wild card here is the fact that if they follow the norms of Congress, they would get a score from the [Joint Committee on Taxation.] And I imagine that a JCT score would not be as favorable to this outlook that tariffs can be such a boom to the economy, and also could create such huge revenues. I'm wondering how that's going to play into it.

There are two ways they could approach this. For some background, they're going to be using the budget reconciliation process. There are lots of rules that determine how they have to go about that, but maybe there are two steps that matter for this particular debate. The first is that they need a budget resolution that is going to set targets for revenue and spending. That is where they would target the size of the tax cut that they are going to want to vote on, and there will be some political limitations there. It's likely that they're not going to reach for the full $5 trillion, which is the cost of extending everything. It's possible that they pull that back. But we don't know exactly how they're going to put that together.

That being said, if they target, say, a $2 trillion tax cut, they're going to have to figure out how to get from $5 trillion down to $2 trillion. One way that they can do that is to legislate actual payfors. One of them could be tariffs. And the scoring outside of the government, so far, has shown that tariffs could raise a significant amount of revenue if those tariffs are very broad. For example, the Tax Policy Center has estimated that a 20% across the board tariff, plus 60% tariff on imported Chinese goods, would raise somewhere around $4.5 trillion over a decade. So we're talking quite a lot of money here that could be used to offset the tax cuts. Now the challenge with that is, when you add it into the legislative process, you also then get into one of the other downsides of [Joint Committee on Taxation] scoring, which is, you get the revenue but you also get the distributional analysis and the dynamic score, and those two things are not going to look very favorable for tariffs. Tariffs are going to be a net drag on the economy, and tariffs are going to look very much like a sales tax, in that they're going to place a larger burden on lower and middle income households than very high income households. Which is already a challenge for the TCJA provisions, which tend to provide larger tax cuts as a share of income to high income households.

Now the alternative to this would be they target a $2 trillion budget number. They find payfors that get them from the $5 trillion down to the $2 trillion. Now some of those payfors might be in the form of making it temporary to some degree, some of them also may be actual payfors from the income tax, but then they have that $2 trillion gap that they have to fill. And then they could just say, well, the Trump administration has enacted tariffs A, B and C. And we think that we have this will produce economic growth. So we'll start with the $2 trillion, and then, given those two factors, we think it's going to pay for itself or be offset by tariffs. This rhetorical payfor method, is something that they did with the Tax Cuts and Jobs Act last time, where they put together legislation that had trillions of dollars of tax cuts, they had payfors that brought it down to $1.5 trillion. Then they said, 'well, we're going to use a current policy baseline for a lot of the business tax provisions, that'll give us $500 billion, and then we also think this will be very pro-growth. So that covers the last trillion dollars. So this is paid for.'

And getting just to the $1.5 trillion turned out to be a huge challenge for them.

Yes. One of the big challenges this time around for the Tax Cuts and Jobs Act is that a lot of that low-hanging fruit is accounted for already and is in the Tax Cuts and Jobs Act extension. So when we talk about the $5 trillion extension, we're talking about extending a lot of these payfors. The $5 trillion is not just the rate cuts, but it's also the $10,000 cap on the state and local tax deduction and the elimination of the personal exemption. Those are already in there, so you can't grab those again. You have to find something else. There'll be a lot of pressure to do to find other things, including tariffs, including dynamic revenue, but also other payfors.

It's almost like the fact that they have full control kind of traps them in a way. Before you had this talk about maybe raising the rate and using that as a payfor, now the expectation is they would keep the rate the same and find new payfors, and maybe do some of the other stuff that corporations are asking for. It almost gives them fewer options.

I think the world in which there wasn't unified Republican control, the outcome of the legislation would be a little bit more uncertain, and also mixed. In that there would be a potential for rate increases, whether that's on individuals or businesses, that wouldn't otherwise occur under the incoming makeup of Congress. I still think that there's uncertainty within the Republican coalition in putting together the Tax Cuts and Jobs Act extension. And that, I think, comes from the very narrow House majority that they're going to have. In 2017 they pulled together a lot of tax cuts and payfors that were discussed and debated over several years, starting in 2011 with Dave Camp's work on tax reform. So they had a starting place, and a little bit more agreement. As time had gone on, since the passage of the Tax Cuts and Jobs Act, there have been certain coalitions of the Republican Party that have voiced concerns about the bill. I think one of the loudest coalitions is the state and local tax deduction coalition within the Republican Party. These would be members that are in, say, California or New York. They're going to put pressure on leadership to lift the cap, which increases the cost from that baseline of $4 or $5 trillion, so there's still uncertainty there. There's also potential that components of the coalition are going to want to see an increase in the child tax credit that's going to also require offsets or payfors somewhere else in the bill. It's not going to be a simple matter of extending this. It's not going to be a simple matter of getting this through the Republican House and Senate. They're still going to be negotiating, and there's still going to be uncertainty.

They could theoretically just pass the budget resolution, including whatever figure you would need to do all of that--I don't know if it's $7 trillion or $10 trillion--and then just say, we're going to do all of this. We think tariffs will pay for it. But regardless, we're going to do it. You think that's just politically going to be very hard, given the huge effect on the deficit.

Yes--for a technical matter, they could just give themselves the budget space to do whatever, and then construct something that gets the number of votes that they need. What's pushing against that is that they still have to vote for something that has a figure attached to it, a deficit figure. And I think the politics of $10 trillion looks a lot worse than, say, $5 trillion, and that looks a lot worse than $2 trillion. I think rhetorically, they're still going to need to make the case that this isn't going to break the bank.

The other big question, for folks in the international sphere, is presumably they're going to want to push back against Pillar Two. You already had these 301 investigations into the digital services taxes. Is this just going to get lost in the noise, you're enacting so many tariffs that people aren't even going to notice these individual retaliations? Is this going to be enough to stop these initiatives? It seems very murky. I'm curious what your take on that is.

I think your observation is correct. It's not clear what either the Trump administration or Congress is going to do in this area. We know going into this that the Republicans, especially in the House, are very skeptical of Pillar Two. In particular, they are skeptical of the undertaxed profits rule, the provision in Pillar Two that applies tax on U.S. domestic activity and U.S. companies that have presence in foreign jurisdictions. They view that as an extra-territorial tax--not a well-defined concept, but that is how it's viewed. And they have expressed the willingness to retaliate against that. They've introduced bills that would enact retaliatory taxes on countries that enact such a tax on the United States. We also know that the Trump administration is very willing to do retaliatory policy in all sorts of areas. I don't think this is going to be any different.

So that's where we start. But what actually occurs is not clear. Starting with this idea that they're going to need to find payfors to make the individual provisions permanent, and also extend business tax provisions. They could end up looking at the current tax treatment of U.S. multinationals as a way to offset some of the costs, or they could be looking at those provisions. This bill is an opportunity to fix some of the provisions that they feel are not structured very well. So GILTI, by no means is a perfect minimum tax, and they may want to take a closer look at that. That could also be paired with provisions that retaliate against foreign countries. And there'll be pressure to do that because of the budgetary things. But we don't know what the shape of those provisions is going to look like.

I know you have views of this, what is the effect of this approach going to be on the economy, and on the U.S. fiscal picture? People are worried about this.

It's a mixed bag. Starting with the Tax Cuts and Jobs Act extensions, if you look at the bill overall, it did a lot of things right--it simplified individual income taxes, cut statutory tax rates, reformed of tax treatment of multinationals, cut the corporate income tax. I think, on net, that was an improvement. Looking at the law, you want to keep a lot of that stuff that made the improvements. The downside, however, is that on net the individual provisions especially are going to reduce federal revenue pretty significantly. So there's a risk there that we make our fiscal outlook much worse. That's a potential downside, even though there are obvious benefits from extending certain provisions of the Tax Cuts and Jobs Act, both for simplicity reasons and for economic growth reasons.

And then on the trade stuff. My starting point here is that trade is good, international trade is good. It has made the United States wealthier on net, and these trade provisions are going to make trade more expensive. They're going to have a negative impact on the U.S. economy. It's not just what the United States does to other countries. It's what those countries do to the United States. And that, in a sense, doubles up the economic harm of any of these provisions. You may think $100 billion in tariffs, that's not a very big deal. Well, it becomes a big deal when other countries start retaliating against that $100 billion dollars of tariffs. The economic damage is going to be far in excess of the amount of revenue that we raise from that. There are some good things that can come out of this, but the downside risks are pretty significant if things go bad.

I do wonder, is Trump going to be keeping an eye on the stock market, and if there's a reaction, would that make him reconsider? This is one thing he has been talking about for decades, he does seem to really believe it.

I think I agree with that. He definitely does believe that these trade policies are going to be good for the United States, but we'll see. Perhaps he will realize, once there is a large negative market reaction to the introduction of significant trade barriers, that he may want to back up.

If you believe that multilateralism and trade is a good thing for the U.S. and a good thing for the world, is there any hope? Is there a way that these things could continue despite this pretty large backlash--not just with Trump, but elsewhere?

It's possible that it won't be as bad as we think. Trump likes to promise lots of things, and many of those promises are just completely unrealistic. For example, exempting Social Security benefits from income tax, that was one of his promises during the campaign, but for a number of reasons, that is just unlikely to happen. It would be very expensive, and depending on how it's structured, could violate the rules in the reconciliation process. We have seen lots of Trump campaign promises that have not materialized. It's possible that this promise to enact significant, broad-based tariffs does not materialize. I think that is our hope, that he ends up doing a little bit of tariffs here and there, and it looks very much like Trump's first term, and he stops with that. If he also is somehow able to help shepherd the Tax Cuts and Jobs Act extension through, and we get that, on balance, that would be a lot better than the alternative where the TCJA fails to get through, or they get it through but only temporarily, and Trump enacts significant broad-based tariffs that stick around for a while.

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