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.
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.
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.
The Nobel prize-winning economist, Paul Krugman, more recently turned partisan flack for the New York Times, has occasionally referred to Republicans as “the stupid party.” After the debacle with the House’s American Health Care Act, maybe he is right. This bill is far from perfect but is a step in the right direction. Its major virtue is a serious attempt to get Medicaid spending under control.
According to an astute analysis by the Wall Street Journal:
The AHCA would put Medicaid on a budget for the first time since its creation in 1965.
Medicaid is now the third largest, and fastest growing, program in the federal budget. Federal outlays are now $360 billion per year, more than three times as much as in 2000.
The federal government matches between 50% and 74% of state costs for Medicaid recipients, which means that the states have little incentive to control spending by allocating resources toward high quality care for the most vulnerable.
A 2013 study by the New England Journal of Medicine found that “Medicaid generated no significant health improvements,” compared to the uninsured.
The AHCA would transition federal funding to a per-capita block grant that would grow with an index of medical inflation. In exchange, governors would gain reform flexibility over the current rigid rules.
Conclusion. It is completely nonsensical for the House Freedom Caucus to oppose such an attractive reform plan just because it isn’t perfect. The members of the Freedom Caucus claim to be fiscal conservatives and to support balanced budgets. And yet they refused to take a simple, practical step to work toward that goal.
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.
Everybody should read Tyler Cowen’s compelling new book, “The Complacent Class.” As I have discussed in two recent posts, here and here, Mr. Cowen lays out the thesis that America has lost much of its dynamism in recent years because life has become so comfortable for so many people, especially the professional elites.
But now things are looking even better yet:
A global economic upturn is under way, especially in manufacturing.
The Federal Reserve is continuing to raise interest rates, confident that fundamental data on employment and inflation (see chart) is looking more and more positive.
Progress is being made on fixing the American healthcare system even if it’s not as good as it could be.
The Republican Congress and Trump Administration are united in their desire for corporate and business tax reform which will give the American economy a big boost when it gets done.
These trends auger well for the American economy in the immediate future. However there is one very dark cloud on the horizon:
Our national debt (the public part on which we pay interest) is now 77% of GDP, the highest since the end of WWII and is predicted by the Congressional Budget Office to keep steadily getting worse without fundamental changes in public policy. In fact, the debt limit, which had been suspended in November 2015, was reinstated by law on March 16. It will have to be raised in the next few months in order to avoid default by the federal government.
I fervently hope that the fiscal conservatives in Congress (such as the Republican Study Group and the Freedom Caucus) will insist on real fiscal restraint going forward as their price for voting to raise the debt limit.
Conclusion. We affluent Americans are so wrapped up in enjoying our good fortune that we lose track of a huge problem on the not so distant horizon. Our prosperity is being heavily financed with borrowed money and we will soon have to pay the piper, unless we are willing to bite the bullet. Do we have the political will to do this?