The Trump administration hit its forecast of 3 percent real GDP growth last year, as new data shows that the economy grew 3.1 percent from the last quarter of 2017 through the last quarter of 2018 (there are other ways to measure this, but I think this way is the most accurate). And its policy contributed to this outcome: The deficit-financed tax cuts added to growth in 2018, as did significant deficit spending.
But before popping the champagne corks, Trump aides should recognize that, contrary to their claims, GDP growth is already slowing. For students of the failed promises of supply-side, trickle-down economics, that’s not a surprise.
Lower taxes or increased government spending that’s not offset by tax increases or spending cuts elsewhere feeds automatically into higher GDP, for the simple, and obvious, reason that both consumer and government spending count as part of GDP. That result isn’t guaranteed: If tax cuts and spending push up interest rates, either through actual overheating or by making the Federal Reserve nervous about potential overheating, that would counteract the growth effects of spending. But even as the Fed began last year with a few minor rate hikes, it backed off, and the interest rate on the 10-year bond is lower now than it was a year ago. Inflation is also in check.
So the big story for last year’s 3 percent growth rate is that deficit spending fueled growth without overheating or “crowd-out” — the theory that public borrowing takes the place of more productive private borrowing, thus pushing up interest rates. This result has ushered in a robust debate about whether deficits matter at all (they do, but it’s nuanced; see here).
But the real problem for the administration is that the growth effects of large 2018 deficits are already fading. And that reveals some bad news about the impact of the tax cuts.
Since around 2010, the GDP’s trend growth rate has been about 2 percent, meaning 2018 came in about a point above trend. In human terms, that means unemployment was about half a point lower than would have occurred absent the fiscal stimulus, which in turn translates into around 800,000 jobs. And while real wages haven’t done anywhere near as well as the administration promised when selling the tax cuts, they have recently been growing in real terms, thanks in part to the high-pressure labor market (as well as lower energy prices).
But for 3 percent to become the new trend, as the fiscal stimulus fades, structural growth accelerators must kick in — most important, faster productivity growth. This, in fact, is the administration’s theory of the case, one immortalized by economist Art Laffer’s supply-side growth story: High-end tax cuts would juice business investment, which would lead to faster productivity growth.
It’s a lovely story, but the data never fail to reject it, which is why you see growth forecasts like those in the figure below. Most forecasters got last year about right, but as fiscal stimulus fades, they predict slower growth ahead. They’re collectively saying that what happened last year was Keynesian stimulus providing a temporary growth bump, not a lasting upshift as in the Laffer story.
These forecasts could be wrong, but Thursday’s report already shows GDP slowing from its faster trend earlier in the year. Moreover, while the business investment data has been solid, it has been what we’d expect at this stage of the expansion, leading economist Dean Baker to conclude that “the evidence is overwhelming that the impact of the tax cut was a conventional Keynesian demand-side stimulus, rather than the investment-led growth that was the ostensible justification for the large reduction in corporate income taxes.”
Finally, whenever we’re talking about GDP growth in our highly unequal economy, we have to ask how much it lifted all boats, not just the yachts. Recent analysis by David Leonhardt at the New York Times finds that after-tax income growth for the wealthiest households has long outpaced GDP growth, while the upper middle class — the 90th to 99th percentiles — has kept pace with GDP. Everyone else has lagged far behind. To be clear, that data takes a few years to come out, but up-to-date information on corporate profitability vs. wage outcomes suggests that these unequal patterns persist.
Sure, we can temporarily juice the economy with deficit-financed tax cuts, but we’ve known that since Keynes. But such stimulus always fades, and if the cuts are structured mostly to benefit the wealthy, the middle class won’t have much to show for them.
So here’s something else we’re learning again even though we’ve long known it was true: Trickle-down economics still doesn’t work.