Responsible Tax Reform III. Avoid Complacency about Debt


The Trump Administration has proposed a tax reform plan, with both good and bad features, and it is not yet known how Congress will respond to it.  In the meantime we should focus on what tax reform can accomplish if does right:

  • Lower tax rates. Most observers agree that lower tax rates will increase economic growth by encouraging more business investment. Since the end of the Great Recession in June 2009, GDP has grown at the historically slow rate of 2% per year. Any additional growth will be beneficial by tightening the job market, thereby creating more jobs as well as higher wages for the already employed.
  • Revenue neutrality. Our public debt (on which we pay interest) is now 77% of GDP, the highest it has been since right after WWII. At the present time interest rates are so low that the debt is almost “free” money. But interest rates will inevitably rise back to more normal levels in the future. When this does happen, whether it be sooner or later, interest payments on our ever increasing debt will skyrocket, and eat up as much as a third of federal tax revenue.  A huge fiscal crisis will then occur, far worse than the Financial Crisis of 2008.

  • Observing historical precedent. There have been five tax rate cuts in the last half century: (Kennedy (1964), Reagan (1981, 1986) and Bush (2001, 2003)).  Note that public debt was 40% or less of GDP at the time of each of these tax cuts (see chart). The revenue losses associated with each was temporary and the first three at least strongly stimulated new growth.

Conclusion. Our national debt is much too high at the present time to adopt a tax reform plan with an extravagant disregard for revenue loss. The current debt level is so high (and projected to keep getting steadily worse) that modest tax rate cuts, coupled with significant spending restraint, is clearly called for.

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The Divided States of America: Who’s at Fault?


Frontline’s two part series, “The Divided States of America” makes the case that the divisive and hyper-partisan political atmosphere of the past eight years was caused primarily by the racially tinged reaction of the extremist Tea Party to the progressive policies of a forward looking, if inexperienced, black president.

I think that Frontline has missed the most fundamental reasons for our current malaise, namely that:

  • Slow economic growth since the end of the Great Recession in June 2009 has caused great angst and resentment amongst middle-income, and especially blue-collar, workers who have stagnant incomes when they observe all around them the elite professional, managerial and financial classes who are doing so well.
  • Self-righteous attitude of progressives who refuse to accept that conservatives have legitimate, and maybe even superior, points of view on various issues.

For example:

  • National Debt. The public debt (on which we pay interest) is now 76% of GDP, the highest since the end of WWII, and is projected by the Congressional Budget Office to keep steadily getting worse without a change in policy. Right now, with ultra-low interest rates, our $14 trillion debt is essentially “free” money. But what is going to happen when interest rates go back up to more normal levels? It could easily be a new fiscal crisis, much worse than the financial crisis of 2008.
  • Inequality. Inequality has risen somewhat in recent years but slow growth is the real problem. What is especially lacking is new business investment to increase labor productivity. The best way to fix this is with tax reform (lower tax rates paid for by shrinking deductions) and a reduction in government regulation. But this would mean more “trickle down” economics. Horrors!
  • Improving Obamacare. The Affordable Care Act has increased access to healthcare but has done nothing to control costs. Most developed countries control the cost of healthcare with a “single payer,” government run monopoly. But this is anathema to many Americans who neither want to give up personal choice nor want to forgo the innovation which a free-market consumer-driven healthcare system provides.

Conclusion. The driver of our currently divisive political climate is a deep chasm between the fundamental beliefs of the two different sides. How can this deep division be overcome short of a new crisis which pulls both sides together?  A very difficult question.

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The Slow Growth Economy We’re Stuck In


We have very high debt and Paul Krugman says in “Debt Is Good” that we need more! The Congressional Budget Office’s latest report this week, “An Update to the Budget and Economic Outlook: 2015 – 2025” predicts slow economic growth for the next ten years, averaging 2.1% per year (see chart below).
CaptureUnfortunately, high debt and slow growth are a deadly, self-reinforcing, combination. Today’s Wall Street Journal has a chart (pictured below) showing clearly how budget deficits are likely to increase over the next ten years. The public debt (on which we pay interest) is predicted to grow from 74% of GDP today to 77% of GDP in 2025, increasing by a total of $7 trillion over this time period.
Capture1Here is another connection between slow growth and high debt:

  • Slow Growth means higher than necessary unemployment and under-employment as well as minimal raises for employed workers. The resulting economic slack leads to
  • Low Inflation. But low inflation means that the Federal Reserve can maintain
  • Low Interest Rates to try to encourage more borrowing to stimulate the economy. This means, in turn, that Congress can run up huge deficits without having to pay much interest on this almost “free” money. This eventually leads to:
  • Massive Debt. But what happens when inflation does take off, which has happened before and is likely to happen again? Then the Federal Reserve is forced to raise interest rates quickly and we are stuck with huge interest payments on our accumulated debt. And meanwhile entitlement spending on Social Security, Medicare and Medicaid is also growing rapidly. At this point debt increases very rapidly which leads to a severe
  • Fiscal Crisis.

Of course things don’t have to happen like this. Congress might become more responsible and either cut spending and/or raise taxes and start shrinking our huge deficits. Or perhaps slow growth really is the new normal and interest rates will remain low indefinitely. But slow growth is not pain free; there are many millions of unemployed and under-employed Americans who want to work and whose lives are stunted otherwise.
Slow growth is a very destructive path to be following. We badly need to adopt policies to speed it up!