Author : BINYAMIN APPELBAUM
Posted : MAY 12, 2017
WASHINGTON — President Trump says the perfect medicine for the economy’s sluggish growth is a big tax cut.
Mr. Trump and his advisers say that leaving more money in the hands of businesses and consumers will lead to more spending and investment, lifting economic growth, which has been stuck in a 2-percent-a-year rut.
Indeed, the Trump administration insists its tax plan will be so good for growth that the federal government won’t even lose any revenue. The government will simply get a smaller share of a much larger pie.
But a range of economists, both conservative and liberal, are highly skeptical that a tax cut is the cure for what ails the economy. They say Mr. Trump has little opportunity to increase economic growth in the next few years because the economy is already growing about as fast as it can. The government’s focus, they say, should be on raising the economy’s speed limit, for example, by encouraging investments that increase productivity
Indeed, by some estimates, Mr. Trump’s plan could reduce economic growth — although such estimates necessarily involve a large dollop of guesswork because the administration has provided few details.
“I don’t think any of this should be thought of as increasing short-term growth,” said Douglas Holtz-Eakin, an economist and former director of the Congressional Budget Office who now runs the American Action Forum, a conservative think tank. He said he remained hopeful, however, that congressional Republicans would push for a different set of changes that could improve the nation’s long-term economic prospects.
Mr. Trump has repeatedly promised a large tax cut for individuals and corporations, aimed at stimulating economic growth, emulating the Republican administrations of Ronald Reagan and George W. Bush. In recent interviews, Mr. Trump has told Bloomberg News that “we need a stimulus” and The Economist that “we have to prime the pump.”
But the benefits are likely to be limited, in part because the nation’s economic circumstances are different now than in the early 1980s or the early 2000s. The recession that began in 2007 was long and deep, but it has been followed by one of the longest periods of uninterrupted growth in American history.
When the economy is struggling, cutting taxes can increase spending by leaving consumers and businesses with more money to spend. That increased demand is valuable when unemployment is high; it puts people back to work.
But during periods of low unemployment, tax cuts can actually be damaging to the economy. If companies find it difficult to respond to the additional demand for goods and services by hiring workers and increasing output, the result is likely to be higher prices rather than faster economic growth.
The unemployment rate fell to 4.4 percent in April, a low level that most economists regard as the normal churn of people moving among jobs. Some economists argue that stronger growth could persuade more people to start looking for work. But that debate is academic because the Federal Reserve is in the first camp. Fed officials have said that if fiscal policy makers step on the gas by cutting taxes, the Fed is likely to step on the brakes by raising interest rates more quickly.
Mr. Trump’s plan also would significantly increase annual federal deficits, adding trillions of dollars to the federal debt. Increased government borrowing drives up interest rates and reduces the financing available to the private sector, both of which weigh on economic growth. An analysis by the Urban-Brookings Tax Policy Center of Mr. Trump’s campaign tax plan — which closely resembles the current White House plan — projected that the net result would be slower growth.
“I think well-designed tax reform could add to economic growth” in the long term, said Jason Furman, a fellow at the Peterson Institute for International Economics who served as chairman of President Barack Obama’s Council of Economic Advisers. “But poorly designed, deficit-increasing tax reforms are as likely to reduce growth as they are to add to growth.”
Economists see little short-term benefit in a tax cut, but they think the government could strengthen long-term growth by focusing on the right problem: productivity.
The speed limit on economic growth depends how much more every American worker produces. The Fed estimates the economy can expand at a sustainable pace of around 1.8 percent a year — close to the actual pace since 2010.
The Trump administration argues that cutting corporate tax rates would encourage investment and research. Kevin A. Hassett, an economist nominated by Mr. Trump to serve as chairman of his Council of Economic Advisers, is one of the authors of a 1995 study that found that previous corporate tax cuts produced “economically significant” increases in investment in 12 out of 14 countries, including the United States. Cutting tax rates would “unleash the bound-up energy of the American economy,” Vice President Mike Pence said on ABC’s “Meet the Press.”
But that benefit to the economy applies only to a corporate tax cut. Economists do not see a similar upside in reducing personal income taxation because there is little evidence that current rates are high enough to discourage people from earning as much money as they can. When Mr. Reagan took office, the top tax rate was 70 percent; now, it is 39.6 percent. “The top tax rates appear to have little or no relation to the size of the economic pie,” the Congressional Research Service concluded in a 2012 report examining the impact of tax cuts on economic growth.
Many economists, moreover, think that larger changes are required to produce a significant shift in corporate behavior. One such idea is included in a tax plan backed by House Republicans, but it is not in the one-page outline the White House released last month. It would allow companies to immediately deduct from income the full value of investments in research or infrastructure or new technology.
“It means that right up front the business is seeing a payoff in sticking money into something that will make it bigger and more productive in the future,” Mr. Holtz-Eakin said.
Even the rosiest estimates of the potential benefits of such changes fall well short of creating the economic growth necessary to offset the cost of Mr. Trump’s plan.
Mr. Furman said he thought he could write a tax code that would increase annual economic growth by about 0.3 percent. Over a decade, that’s enough to add about $1,500 to the average family’s income.
Others are slightly more optimistic. The Tax Foundation thinks 0.4 percent is a reasonable estimate of the best case. Mr. Holtz-Eakin said that he regarded 0.5 percent as an upper bound on the potential benefits.
But that is still only about half the growth required by Mr. Trump’s plan. And that is as good as it gets. “I don’t know anyone remotely sane or credible that would put a number higher than that,” Mr. Furman said.