To the extent that President Trump's proposed "tax reform" obscures or worsens this inconvenient reality, it is a dangerous distraction. We cannot afford large tax cuts, which are pleasing to propose ("something for nothing") but involve long-term risks that are not understood by the president or, to be fair, by economists. Piling up massive peacetime deficits is something we haven't done before. We cannot know the full consequences.
Of course, Trump proposes some good ideas. Tax rates would drop for businesses and individuals. Many deductions would end. Some tax relief would go to low- and middle-income households with children — a deserving group. There are also familiar complaints. Too many benefits, it's said, go to the wealthy. (A similar plan by candidate Trump channeled nearly half the cuts to the richest 1 percent, said the nonpartisan Tax Policy Center.)
But the plan's fatal defect is its effect on the publicly held federal debt. In 2016, this was $14 trillion, or 77 percent of the economy (gross domestic product). "During only one other period of U.S. history — from 1944 through 1950, because of the surge in federal spending during World War II — has that debt exceeded 70 percent of GDP," the Congressional Budget Office says. Under present policies and reflecting the older population, the CBO projects the debt to reach $25 trillion and 89 percent of GDP by 2027.
Just how much Trump's tax plan would add to this is unclear. We don't yet have sufficient detail to judge. But the amount could be considerable. Lower rates aren't matched by revenue-raising provisions. The nonpartisan Committee for a Responsible Federal Budget puts the likely 10-year cost at $5.5 trillion with a range from $3 trillion to $7 trillion.
Why is this bad? Three standard reasons are routinely given for avoiding large and escalating deficits.
First, the government’s extra borrowing might raise interest rates, crowding out productive private investment. This would reduce economic growth and undermine living standards.
Second, some national emergency (war, pandemic, a natural disaster) might compel large borrowings that would be difficult — except at onerous interest rates — because the government’s credit rating was impaired.
And third, too many dollars in the world — as cash, stocks, bonds and other securities — would lead to a crisis of confidence. Investors, banks and other financial institutions wouldn’t want to hold so many dollars. The panic to sell dollars and dollar securities would cause crashes in global stock, bond and commodities markets.
Truth be told, economists have been making these arguments for years. None has yet come true. It’s conceivable that they might never come true. The global demand for so-called “safe assets” — financial securities that investors can trust — might sustain a growing worldwide supply of U.S. Treasury securities that, despite our problems, are still regarded as highly reliable. If so, we could cut taxes and not worry about deficits.
But that’s a huge gamble on the future. Do we really want to bet that what seems true today will be true a decade and roughly $15 trillion more in government debt from now? Prudence suggests not. If we lose the bet, the outcome might make the 2008-2009 financial crisis and Great Recession look like a cakewalk.
Taxes will ultimately follow spending upward. Even if some programs are cut, the popularity of most programs — led by Social Security and Medicare — and an aging population ensure that government spending as a share of the economy will rise.
Not to worry, says Treasury Secretary Steven Mnuchin. Trump's tax cuts "will grow the economy and will create . . . trillions of dollars in additional revenues." It's painless.
The reality is that there is no automatic and guaranteed relationship between major "tax reform" and economic growth. Although lower tax rates may stimulate the economy, the effect may be neutralized by other forces (higher interest rates, weaker foreign economies, cautious consumers). Studies by the U.S. Treasury and Congress's Joint Committee on Taxation project small gains in economic growth from tax reform.
There is a fundamental gap between what most Americans expect from government — from highways to defense to support for the elderly — and the corresponding tax burdens. The disconnect cannot be erased by massive tax cuts. There is no spending discipline. Sooner or later, we will face higher taxes, whatever happens to Trump’s present proposals.
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