Fears over debt load take shine off tax reform
Problems of wealth inequality could put a brake on growth
Sam Fleming in Washington
Even as US stocks roared higher on Monday in response to the passage of the Senate tax bill many analysts were expressing deep scepticism about the notion that the overhaul will transform an economy that is already running close to full employment.
Kent Smetters, a former Bush administration official who oversees the Penn Wharton Budget Model, said he expects at most a 0.1 percentage point uplift to annual growth rates over the course of 10 years as a result of the legislation. The long-run impact on trend growth will be negligible, he added, as the extra debt amassed as a result of lost revenue weighs on the economy. “It is not a significant boost,” he said.
Politically there is no doubt that the passage of the package comes at a highly opportune moment. The US has seen two successive readings of annual GDP growth running at 3 per cent or more, and the Atlanta Fed’s model points to 3.5 per cent growth for the final quarter of the year.
Assuming the legislation goes through, it will effectively put Republicans in a position to adopt the recovery as their own, pointing to their tax changes as fuel for the continued growth and potentially boosting their prospects in 2018’s midterm elections. Kevin Hassett, the chairman of the Council of Economic Advisers, told the FT before the Senate deal went through that significant tax reform would mean “at the very least the odds of sustaining growth at the 3 per cent level go up enormously”.
But the GOP will also have to take responsibility for widening deficits, with the Committee for a Responsible Federal Budget projecting that tax and spending legislation currently on the agenda could propel the US back to trillion-dollar deficits as soon as 2019. And the package arguably leaves unaddressed longer-term economic challenges alongside rising public debt, including higher inequality, poor educational outcomes, and slowing labour force growth.
The House and Senate now face the difficult task of reconciling their two versions of the legislation, as they dash to get a bill on the president’s desk by the end of the year. But the increasing likelihood of the tax bill’s becoming law is prompting analysts to boost their growth forecasts for the very short term.
Alec Phillips, a Goldman Sachs analyst, said the tax revenue reduction is worth around 0.6pc of gross domestic product in 2018 and 1.1pc of GDP in 2019. Looking at how much of this is actually going to be spent, and therefore turns up in extra GDP, it translates into a 0.3 percentage point boost to 2018 GDP and a 0.3 percentage point uplift to 2019 GDP, he said. “After that the size of the tax cut flattens off and starts to decline somewhat, so we don’t estimate any additional uplift to GDP in 2020.”
The main benefits being touted by the White House stem from reduced individual tax rates and the slashing of the headline corporate tax rate from 35 per cent to 20 per cent, which its economists expect to translate into higher investment and therefore increased wages. President Donald Trump on Monday took full credit for the soaring stock market as he brandished the tax cuts, declaring on Twitter that “jobs are roaring back”.
The Senate’s decision to delay the cut in the corporate rate to 2019, while allowing companies to immediately deduct capital investments from 2018, could further induce firms to rush through investments next year, according to Scott Greenberg of the Tax Foundation. This is because firms would be able to deduct the full cost against a 35 per cent rate but the profits from the investment would later be taxed at 20 per cent. He describes the effect as a “huge deal” in the short term, although not all analysts expect the big uplift to GDP from the measure that he does.
Over the longer term, the tax bill’s effects are far more ambiguous. Jason Furman, who chaired Barack Obama’s Council of Economic Advisers and is now at the Harvard Kennedy School, said that higher debt would gradually impose a mounting counterweight on the economy’s performance beyond next year. He said he too would advocate business tax reform, but “I would make sure it is paid for and make sure it does not open up new loopholes”.
What’s more, analysis of previous iterations of the tax overhaul has suggested that the benefits would be skewed to the richest in America, in part because holdings of corporate equities are concentrated in wealthier groups. In 2027, when the individual tax cuts will have expired, more than 60 per cent of the benefits would accrue to the top 1 per cent of earners, according to the Tax Policy Center. By that year, taxes would rise modestly for the lowest-income group, change little for middle-income groups, and decrease for higher-income groups.
Janet Yellen, the Federal Reserve chair, has described rising inequality as “disturbing” and suggested that if income is being shifted towards wealthier groups it could lower overall spending growth.
“I don’t think it is going to be a big benefit and it seriously intensifies the wealth inequality problem,” said Bill Cline, an economist at the Peterson Institute for International Economics. He said the principal beneficiaries of the package are likely to be holders of corporate shares and the top 1 per cent. The $1tn budget shortfall expected over the coming 10 years as a result of the plan could prompt some lawmakers to argue for cuts to social spending, which could further hurt those who are poorly off, he predicted.
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