In Tax Overhaul, Trump Tries to Defy the Economic Odds
Posted December 20, 2017 11:56 p.m. EST
Updated December 21, 2017 12:00 a.m. EST
When President Donald Trump adds his distinctive signature to the tax bill, he will also be making a huge bet that the Republican strategy of deep cuts for businesses and wealthy individuals will fuel extraordinary growth across the board.
Perhaps more than any other American political leader, Trump knows that long shots, like his own presidential bid, sometimes pay off. In that vein, he and congressional Republicans are arguing that their bitterly contested and expensive rewrite of the tax code will ultimately create more jobs and raise wages.
If they are proved correct, they will be repudiating not only historical experience, but most experts. From Congress’ own prognosticators to Wall Street’s virtuosos, scarcely any independent analyses project anything like the rosy forecasts offered by the president’s top economic advisers.
To Trump and his allies, the normal models just do not fully capture the high-octane “rocket fuel” embedded in the tax plan. Trump intuitively understands just how much attitudes and expectations can shape economic decisions.
With a businessman in the White House, Trump argues that companies, large and small, have a renewed faith in the economy. And the corporate tax cut, combined with the rollback in regulation, will prompt waves of new investment and hiring, as middle-class Americans liberally spend the extra money in their pockets.
“We’re going to easily see 4 percent growth next year,” the National Economic Council director, Gary Cohn, said. Steven Mnuchin, the Treasury secretary, declared the tax plan would generate enough growth to more than pay for its $1.5 trillion cost.
But those pronouncements are at odds with estimates from the former employer of both men, Goldman Sachs. The bank projected that the tax bill will add just three-tenths of 1 percent of growth in the next two years, before its impact peters out.
The firm’s annual growth estimate of 2.5 percent for 2018 matched the one issued this week by the nation’s central bank, the Federal Reserve, while the latest median Wall Street forecast hovered close by. And in 2019, growth is expected to drop to 1.8 percent, Alec Phillips, chief U.S. political economist for Goldman, said Wednesday after the Senate vote.
“We note that the effect in 2020 and beyond looks minimal and could actually be slightly negative,” the company said in a recent published summary.
Such projections are unlikely to deter Trump and Republican leaders from declaring success next year. Lower taxes and extra incentives to invest in 2018 are almost certain to encourage consumers to spend and businesses to expand.
Reduced rates mean most Americans will start taking home more money right away. Roughly three-quarters of taxpayers are expected to get a cut next year, according to the nonpartisan Tax Policy Center.
Employers may offer other sweeteners, even if they were not specifically spurred by the tax plan. AT&T announced Wednesday that it was giving more than 200,000 domestic employees a $1,000 bonus when the tax bill is signed. Fifth Third Bancorp, based in Cincinnati, also promised a $1,000 bonus and said it would raise the company’s minimum wage to $15 an hour.
At the same time, the anticipated cut in the corporate rate to 21 percent from 35 percent and other business perks are lifting the stock market to new heights. In an earnings call this week, Alan B. Graf Jr., FedEx’s chief financial officer, said the company planned to use part of its tax windfall to fatten dividends.
But like a shot of adrenaline, that initial burst of economic activity is likely to fade.
Some provisions of the bill were intended to be sharp and short. Next year, for example, businesses will be able to borrow money and deduct the cost of those loans at the current rate of 35 percent. But later on, when they reap the profits, they will pay a tax rate of only 21 percent. That could end up causing firms to simply shift the timing of investments they would have made regardless of a change in the tax code.
“The really hard question a year from now is going to be is how much of the miniboom we see is just an acceleration of stuff that was going to happen anyway or additional investment that is really going to spur the economy,” said Mihir A. Desai, a professor of finance at Harvard Business School.
Tax cuts can provide an added incentive to invest. But as most chief executives acknowledge, they are generally not the crucial factor.
Investment decisions are much more closely linked to demand for goods and services or technological advancement. As it is, manufacturers are not making full use of the capacity in their existing facilities.
Graf of FedEx held out the possibility of more spending on capital investment and hiring next year. But he noted that the economy as a whole would first have to “increase materially.”
Over time, most of the broad-based tax cuts will disappear. Although the richest sliver of Americans will continue to get a break, most people who earn less than $100,000 will see their taxes rise, which could slow the economy’s primary engine, consumer spending.
Further tightening is likely if the Republicans follow through on sharply cutting Medicare, Medicaid, Social Security and other programs that tend to put extra cash into the pockets of lower and moderate-income households. Either way, the deficit will continue to balloon. Over the last decade alone, the deficit has more than tripled. So far, the interest needed to cover that enormous loan has remained relatively small because interest rates have been at historically low levels.
But those costs are expected to soar. The Federal Reserve has indicated that it intends to slowly but surely raise the benchmark interest rate.
Some economists support such deficit spending during recessions, but they worry that offering stimulants when the economy is on fairly steady ground can backfire. Although employers have resisted raising salaries by much, they continue to complain about the tightness of the labor market. The jobless rate has dipped to 4.1 percent while job openings have remained at record high levels.
Virtually no economists believe that the tax cuts will pay for themselves. Several studies have shown that they rarely cover more than a third of the cost. Others have questioned whether cuts produce any significant growth at all — even if they do encourage some individuals to work, save and invest. In a study that William G. Gale and Andrew Samwick did for the Tax Policy Center, they concluded that cuts that increase budget deficits “in the long term will reduce national saving and raise interest rates.”
The pattern of short-term promise followed by disappointment is one that other presidents have experienced. President Ronald Reagan in 1981 and President George W. Bush in 2001 and 2003 both passed tax cuts that delivered temporary bumps to the economy followed by slowdowns and rising deficits.
“The clear consensus among independent economists is that the impact of the tax cuts on growth is nowhere close to what the administration is talking about,” said Desai of Harvard. Whatever growth does occur, he added, will be “counteracted by the fiscal irresponsibility of the bill.”