How Donald Trump Could Redeem Himself

 

From a reader of my blog:
I think he is too flawed, self-centered and sociopathic to accomplish much. I believe that tax reform will become tax cuts for the wealthy (no inheritance tax, etc.) and dealing with budget deficits will not happen. I know you think Trump will be contained by the conservative members of Congress. The Republicans seem unwilling to confront him or speak out as long as his base continues to be very loyal. I think he is so wounded now that it will be hard to accomplish much.


Granted that Donald Trump is hopelessly ensnared in controversy and incapable of changing his ways, he still has many opportunities to do something positive. For example regarding our extremely serious debt problem, he could focus on:

  • Coming up with a budget that reduces the debt path. No one expects the budget to be balanced in one year. Last year’s Republican plan would have taken ten years to get the job done. The important thing is to clearly move in this direction.
  • Focusing healthcare reform on cost control. Give the Democrats credit for expanding healthcare access with the Affordable Care Act. But now focus on reining in the cost of healthcare in America.

  • Enacting fiscally responsible tax reform. Most people agree that the tax code is a complicated mess and, especially, that the corporate tax rate is too high. There are many ways to achieve lower tax rates and simplification in a revenue neutral way.
  • Stop digging the debt hole deeper by just adding new initiatives. There will always be attractive new programs which are worth pursuing. But in adding them to the federal budget, other programs which are no longer effective need to be phased out.
  • Reforming entitlements such as Social Security, Medicare and Medicaid. These are the big drivers of national debt. Without entitlement reform, all other efforts to restrain federal spending will be insufficient.

Conclusion. There is nothing easy about pursuing the above agenda. Implementing it will be highly controversial with lots of vociferous opposition.  It will take strong leadership to push it through.  But it represents a huge opportunity for a controversial president to do something worthwhile.

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What Will Happen if We Have a New Fiscal Crisis?

 

As I often remind the readers of this blog, the two main topics are what I consider to be America’s two biggest economic and fiscal problems:

  • Slow economic growth, averaging just 2% since the end of the Great Recession in June 2009. This means fewer new jobs and smaller raises.
  • Massive debt, now 77% of GDP for the public part on which we pay interest, the largest since the end of WWII and predicted by the CBO to keep getting worse. As interest rates rise from their currently unusually low levels, interest payments on the debt will skyrocket.

 

The first problem, slow growth, is being addressed by the Trump Administration with various deregulatory actions as well as likely tax reform action by Congress.  Furthermore, the current low 4.4% unemployment rate means that the labor market is tightening on its own.


The second problem, massive debt, is much more worrisome for the future.  Right now interest rates are so low that our entire debt is essentially “free” money.  But every 1% increase will add nearly $150 billion per year in interest payments.  And this continues indefinitely (and keeps getting worse with more debt) because debt is rarely if ever paid back, it is only rolled over!  What are the likely outcomes of such an upward spiral in interest payments?  There are two possibilities:

  • First, the unthinkable. We default on our debt. This would immediately end the role of the U.S. dollar as the international currency and end our superpower status. The fallout would be disastrous for world peace and stability.
  • Second, a huge tax increase. The only alternative to default will be a large tax increase just to keep afloat on interest payments. A likely new tax for this purpose is a consumption tax in the form of a value added tax.

Conclusion. It is extremely shortsighted to keep on delaying a necessary solution to our rapidly worsening debt problem. It’s going to be unpleasant to either cut back on spending or to raise taxes but the longer we delay action the more painful it will become in the end.  Isn’t it obvious that we should get started immediately?

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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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Responsible Tax Reform II. The Trump Plan

 

Responsible tax reform will be highly beneficial for the U.S. economy because:

  • Economic growth will be speeded up by lowering tax rates on businesses, thereby encouraging more investment.
  • National debt will shrink because faster growth will produce more tax revenue. But this only works if the revised tax plan is revenue neutral to begin with.

The Trump tax plan, described here and here, has the following features:

  • three tax brackets, reduced from seven. Simplification like this is a good idea.
  • double the standard deduction. This puts more money in the pockets of the average tax payer who does not itemize deductions and is therefore a good idea.
  • repeal of the alternative minimum tax. This only affects wealthy people and should be retained, if necessary, to make sure that overall reform does not increase the deficit.
  • lower capital gains tax. This will encourage more investment but should not be included unless the overall plan is revenue neutral.
  • repeal of inheritance tax. This tax feature should be retained until our annual budget deficits are eliminated, i.e. until we achieve balanced budgets on an annual basis.
  • preserving deductions for mortgage interest and charitable contributions. The mortgage interest deduction should be greatly reduced from its current level of $1 million per residence. Wealthy taxpayers don’t need that much help. Raising the standard deduction will already help middle income taxpayers.
  • cutting the corporate tax rate. This is an excellent idea as long as its revenue loss is made up elsewhere. It will encourage multinational corporations to bring their overseas profits back home for reinvestment in the U.S.

Conclusion. The Trump tax plan has some good features as well as some poor ones. Reducing tax rates is a good idea.  But adding to annual deficits is a very bad idea.  With some effort it is possible to reduce tax rates in a revenue neutral way.

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Principles for Responsible Tax Reform

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.

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What to look for in President Trump’s First Budget

 

As a new administration prepares to take office in January, one of the key indicators of President Trump’s approach to government will be his first budget. This is especially true since the Republican controlled Congress is likely to take a Republican President’s budget seriously.

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One of our nation’s chief fiscal watchdogs, the Concord Coalition, has summarized the most important things to look for:

  • What is the overall fiscal target? President Obama’s recent budgets have aimed at stabilizing the debt as a share of the economy. House Republicans have aimed for a more ambitious goal of balancing the budget within ten years, gradually reducing the debt as a share of the economy. What path will Mr. Trump recommend?
  • What specific tax cuts will be proposed and what are the likely revenue effects? During the campaign Mr. Trump proposed tax cuts amounting to $5.9 trillion in revenue loss over ten years. Even with dynamic scoring, taking the stimulatory effects of his tax cuts into effect, the revenue loss is still $3.9 trillion over ten years. Such huge revenue losses will make our debt much worse than it is already and won’t be approved by Congress.
  • What will the budget recommend for the federal debt limit? Currently the debt limit is suspended until March 16, 2017 when it will return at whatever level it is on that date. Congress will then have several months to reset it. Whatever the President recommends will send a strong signal, positive or negative, to the financial markets.
  • What economic growth rates will the budget assume?   GDP growth has averaged 2.6% for the past 30 years. Any predicted long term growth rate higher than this will lack credibility without strong justification.

Conclusion. Mr. Trump has the opportunity to institute the change in course which so many Americans would like to see. His first budget will set the tone and provide an important clue as to whether or not he is serious about doing this.

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How to Get Our Economy Back on Track III. Tax Reform

 

Both political parties, both presidential candidates, most prominent economists and economics journalists, in other words, most opinion makers, favor faster economic growth. I have had several recent posts on this topic, here and here, pointing out especially the need to increase the rate of growth of worker productivity which in turn is heavily influenced by the rate of new business investment.
One of the most valuable policy changes in this respect is tax reform, with lower marginal rates paid for by closing loopholes and shrinking deductions. The Republican House of Representatives has developed an excellent plan, “A Better Way,” which includes such extensive tax reform.

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The American Enterprise Institute has recently analyzed the House plan and describes the positive impact it would have on our economy:

  • Simplification. The seven current individual tax rates would be reduced to just three: 12%, 25% and 33%. All deductions would be eliminated except for mortgage interest and charitable contributions. The standard deduction would be almost doubled. A 50% exclusion for capital gains, dividends and interest income would lower those tax rates in half.
  • Business taxes. The corporate tax rate would be cut from 35% to 20%, again by eliminating most deductions, and a territorial system adopted whereby taxes are only paid in the country where business is conducted. Immediate expensing for new investment would replace multiyear depreciation.
  • Effects. Base broadening by eliminating deductions will add 6.5 million new taxpayers. The number of taxpayers taking the standard deduction will increase by 37 million (from 70% to 95%). Total tax revenue will decrease by $227 billion over ten years. The effective marginal tax rate is slightly lower for most income groups.

Conclusion. The overall lower tax rates will boost economic growth. The ten year loss of tax revenue, while relatively small, is still a detriment and should be eliminated by shrinking the remaining mortgage interest deduction (which primarily benefits the wealthy).

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