President Trump has just unveiled the outline of his tax reform proposal. Tax reform done right can give our economy a needed shot in the arm. The big question is, of course, what is the right way to do it?
The Committee for a Responsible Federal Budget has proposed some sensible guidelines:
Promote Economic Growth and Dedicate the Gains to Deficit Reduction. The Joint Committee on Taxation and the Treasury Department have estimated that comprehensive tax reform can increase the growth rate of GDP over the next decade by .05 to .25% per year. For example, a .2% increase would reduce our debt by $550 billion over ten years (see chart). This does not fix our fiscal problems but it helps.
Maintain or Reduce Current Deficits. Make sure that any tax rate cuts are offset by revenue increases (i.e. shrinking tax deductions) so that the annual deficit is not increased. Ultimately, our fiscal challenges are unlikely to be solved without reducing spending, reforming entitlements and increasing revenue.
Set Permanent Tax Policy. The reconciliation process in the Senate, whereby a simple majority can approve legislation, disallows any increase in the debt beyond ten years. In other words, permanent tax reform will require a sixty vote majority to override a filibuster. This is the only way to achieve sound policy.
Avoid Unjustified Timing Shifts and Other Gimmicks. A timing shift is a gimmick if it doesn’t make economic sense. For example, gradually reducing tax rates, rather than cutting them immediately, would only delay revenue losses by shifting them to the future, and is therefore a gimmick.
Rely on Reasonable Economic Assumptions. A good example of a faulty economic assumption is to arbitrarily assume that a tax rate reduction will create 3% annual GDP growth and therefore pay for itself over a sufficiently long time period. Such a proposal was made by the economist Stephen Moore in yesterday’s Wall Street Journal.
Conclusion. Slow economic growth and massive debt are our country’s two biggest problems. Tax reform done right will speed up growth without worsening the debt. I will be paying close attention to the forthcoming debate on this issue.
I began writing this blog in November 2012, right after the 2012 national election when Barack Obama was reelected to a second term as President. Under Obama our biggest problems were: 1) slow economic growth (2% annually since June 2009) and 2) massive and rapidly increasing debt, now 77% of GDP.
After the surprise victory of Donald Trump last fall, my perspective has changed a little bit. Slow growth is still a huge problem. My last several posts have, in fact, focused on the despair of many blue-collar workers who have been harmed by our stagnant economy in recent years.
Mr. Trump was strongly supported by blue-collar workers last fall and clearly wants to help them out. Faster economic growth will accomplish this and President Trump is working with the Republican Congress to get this done through tax and regulatory reform. I’m optimistic that progress will be made along these lines.
But our debt problem has not really been addressed so far by the Trump Administration. James Capretta from the American Enterprise Institute gives a good summary of where we are:
Entitlement Spending is the Problem. In 1972 the federal government spent a combined 4.2% of GDP on Social Security, Medicare and Medicaid. In 2016 spending on these programs was 10.4% of GDP. The Congressional Budget Office predicts that this figure will jump to 13.5% of GDP in 2030 and 15.6% of GDP in 2047 unless current policy is changed.
The Fiscal Consequences of Interest Rate Normalcy. In 2008 when federal debt was at 39% of GDP, federal spending on net interest payments was 1.7% of GDP. For 2017 net interest payments will be just 1.3% of GDP even though the federal has doubled since 2008. This is due to the abnormally low interest rate of 2.3% at the present time. CBO projects that the interest rate on 10-year Treasury notes will rise to 3% in 2019-2020 and 3.6% for the period 2021-2027.
Conclusion. Right now our huge and rapidly increasing debt is almost “free money” because interest rates are so low. This can’t and won’t last. As interest rates inevitably climb to more normal levels, interest payments on the debt will rise precipitously. This will cause much pain by further squeezing spending on many popular programs. The only sane way to mitigate this highly unpleasant prospect is to shrink deficit spending down to zero as quickly as possible.
It would run from TD Ameritrade Park in downtown Omaha to 42nd and Farnam Streets in midtown Omaha, a distance of about four miles. It would cost about $7.5 million per year to operate the line and would generate about $700,000 a year in annual revenue with a fare of $1.25 per ride. Adding a fee of $1.50 per ticket per College World Series event (at TD Ameritrade Park) would generate about $500,000 per year in additional income.
The financial assessment of the project by HDR suggests that the Federal Transit Administration could be asked for a grant of $78 million, or one-half of the total cost. The FTA is already contributing $15 million towards a $30 million Bus Rapid Transit system along Dodge Street approved by the City Council. The BRT involves 27 sleek, modern bus stop shelters along the route at a cost of $260,000 each.
The FTA has an annual budget of $19 billion. The Trump Administration is asking for a $2.4 billion cut in the FTA budget for 2018. Congress has not yet taken any action on the Trump Budget proposal. But the FTA budget is clearly funding extravagant local projects around the country and is ripe for a major budget cut.
Conclusion. Omaha is simply not large enough, nor with a sufficiently dense population base, to support a downtown street car system aimed at the tourist trade. It could only be financed with massive federal support at a time when the federal government is rightly trying to cut back on unnecessary and wasteful spending. Don’t do it, Omaha!
So declared Douglas Holtz-Eakin, former director of the Congressional Budget Office, in March 2011. At the time, federal debt held by the public (on which we pay interest) stood at 63% of GDP. Now, just six years later, that ratio stands at 77% and is projected by the CBO to reach 150% by 2047 if current laws remain unchanged.
The CBO has just released its latest (March 2017) report and the debt situation continues to get worse:
The interest rate on federal debt has averaged 5.8% over the past 60 years. It is now at an unusually low 2% and the CBO projects that it will climb no higher than 4.4% by 2047. Even with such a conservative projection, the total cost of servicing the debt will rise to almost 1/3 of federal revenue by 2047, compared with just 8% today.
Here are some of the dire consequences of such a large and growing debt:
Reduces national savings and income in the long term because more of people’s savings would be used to buy Treasury securities, thus crowding out private investment.
Increases the government’s interest costs and thus makes it much more difficult to lower deficits.
Reduces the ability to respond to unforeseen events. For example, when the Financial Crisis hit in 2008, public debt stood at 40% of GDP and lawmakers had the flexibility to respond to the crisis with both TARP and a fiscal stimulus. Such costly actions will be much more difficult next time.
Increases the chances of a new fiscal crisis if investors become less willing to finance more federal borrowing or demand higher interest rates in return.
Conclusion. The more debt that accumulates and the higher interest rates rise, the more painful it will become to implement a solution. What is really scary is that nothing will be done until a new crisis occurs. Then we will be forced to act and it will be very painful indeed.
The anti-Trump fervor seems to be slowly dying down as his appointees take hold of their agencies and begin to promulgate new policies. I have expected this to happen because of the excellent quality of many of the people he has appointed.
Here are a few recent developments:
Interior Secretary Ryan Zinke has said that “the border is complicated as far as building a physical wall” and there are all sorts of problems to be resolved before it can be done.
Reality is setting in with regard to Russia policy “given Russia’s continued provocations in terms of weapon’s deployments, overtures to Iran, cyber intrusions and intervention in Ukraine.”
The Brookings Institution has just issued a new report showing that schoolchoice options are increasing in the country’s largest school districts. This indicates that Education Secretary Betsy DeVos is in the mainstream by supporting more choice.
Coal jobs Trump vows to save no longer exist. In other words, cancelation of the Obama Clean Power Plan will have little effect on the huge drop in coal use because coal has become so much more expensive than natural gas.
Of course, the Trump 2018 Budget Proposal will be heavily modified by Congress but it does contain some good ideas. Agriculture, Foreign Aid and Community Development Block Grants are all ripe for big cuts.
The biggest unknown with respect to administrative action concerns trade policy. The question here is what concessions he can get from China and Mexico without starting a disastrous trade war.
What is mainly lacking at this point is any significant action by Congress on the Trump agenda. What will happen with healthcare reform, tax reform and deficit reduction, for example?
Conclusion. Trump is doing fine so far but it is on relatively straightforward issues under his control. Hopefully he will be able to make progress on the bigger issues as well which require working with Congress.
To some readers, I am sure, I must sound like a one-note Johnny. I have a fixation on our national debt because it is so massive and so many apparently well-informed people are so complacent about it. Sometimes I feel like I’m beating my brains out by discussing this issue so often. But I don’t know what else to do.
I recently came across an article from a year ago in Time Magazine by James Grant, the editor of Grant’s Interest Rate Observer. Elaborating on Mr. Grant:
As recently as 2007 our public debt (on which we pay interest) was $5 trillion and, with an average interest rate of 4.8%, net interest expense was $237 billion. In 2016 we owed $14.1 trillion and paid an average interest rate of 1.8% for an interest payment of $240 billion. In other words, although our public debt has almost tripled in ten years, the interest rate is just over 1/3 of what it was in 2007. So our interest payment hasn’t changed.
Interest rates are now starting to head back up. If they return to the 2007 level of 4.8%, then today’s public debt ($14.9 trillion in 2017) would require an interest payment of $715 billion. At the rate of 6.7%, prevailing in the 1990s, today’s debt would require an interest payment of $998 billion. That represents almost 1/3 of today’s total federal revenue.
Here’s a related perspective from Jon Hall who writes for the American Thinker:
Most of our debt is financed with 10 year Treasury Notes. “Of the marketable securities currently held by the public as of 9/30/15, $7.4 trillion or 58% will mature within the next four years.” (see GAO chart) In other words, the huge increase in debt over the past 10 years will soon have to be paid for by Treasury. This will almost surely cause more inflation which will lead to a further increase in interest rates.
Conclusion. Unwinding our current debt will require painful cutbacks over a period of years. But right now we are making the problem even worse with continued deficit spending. How will our increasingly perilous situation ever be reversed?
I’ve had several posts recently elaborating on the theme of Tyler Cowen’s new book, “The Complacent Class,” that too many Americans have become complacent about the comfortable life which they now enjoy.
Let’s take a different approach today and consider some of the problems which large numbers of Americans really are concerned about:
The election of Donald Trump as President. Granted, he just barely squeaked through in the Electoral College with 46% of the popular vote. He makes outlandish statements which have little, if any, basis in fact. But he has appointed many capable cabinet secretaries and other assistants and he listens to them. He adjusts his policies when struck down by the courts. In my opinion he has suffered no major mistakes so far.
Increasing income inequality in American society. This is a problem but, as Nicholas Eberstadt has pointed out, the real problem is income insecurity for millions of blue-collar workers. The best solution here is faster economic growth which the Trump Administration and the Republican Congress hope to achieve through tax reform and deregulation.
Global Warming. More and more Americans understand the increasing severity of this problem. There is a fair chance that a revenue neutral carbon tax will be implemented in the near future. This would be a big boost toward controlling carbon emissions in the U.S. and would provide more clout in establishing worldwide emission standards as well.
A chaotic world. Terrorism will not go away but at least ISIS will soon be defeated as an independent state. Other worldwide threats such as China, Russia and Iran can be managed with a strong U.S. military force undergirded by a strong U.S. economy.
Conclusion. The above problems are considered by large numbers of people to be serious and are therefore being addressed in one way or another. But our biggest problem of all, massive debt, is off the radar for much of the political class, including President Trump. It needs to be taken far more seriously than it is before we have another, and much more severe, financial crisis.