The Great GOP Stimulus

The 2018 Trump stimulus exceeds the Obama-era stimulus package in size – will it pay off at the top of the economic cycle?

In 2010, when Barack Obama pushed for a stimulus package to help boost the American economy, it was decided by many in the GOP as wasteful spending. While there are more productive (infrastructure) and less productive¬†(tax rebates) ways to stimulate the economy, any form of spending (or tax cut) is a form of economic stimulus – this is a point agreed by both economists and businessmen like Warren Buffet. In fact, any form of budget deficit is a form of stimulus, as the government borrows (or prints) money that it doesn’t have to spend it into the economy.

The past year has seen the GOP enact not one but two stimulus measures – first a budget which ended Obama-era budget caps and boosted spending by roughly $150B per year, and second the tax cut which reduces taxes by another $150B per year. Taken together these measures are adding roughly $300B per year in stimulus to the US economy, potentially adding 1.5% to GDP for each of the next few years. Adding this stimulus to a core GDP growth rate of 2-2.5% might thus make 4% possible in the near term, with the bill due much later. The total federal (non-central bank) stimulus under President Trump’s first will hit at least $1.2 Trillion, exceeding President Obama’s 2010 stimulus package by $350 Billion [1], but this time at the top of the economic cycle!

What does this tell us? A few key takeaways emerge:
  • While most economists agree that it’s better to do fiscal stimulus when the economy is at or near recession, democracies don’t work this way, and there’s little correlation between economic need and actual governance.
  • When either party has complete control of government, they take the opportunity to spend on favored initiatives – in Trump’s case the DoD received most of the benefit, while in Obama’s case a variety of energy efficiency, infrastructure, and other initiatives were funded.
  • Budget deficits haven’t been a major issue over the last decade, but the tax cuts in particular will layer on top of Social Security and healthcare spending trends to drive debt-to-gdp well past 100% [2].
  • The best stabilizers in the US economy (unemployment insurance) are effectively automated – extending this sort of stabilizer to infrastructure spending (spending more on transportation funding etc as unemployment rises) would not just help buffer downturns – it would also get taxpayers a better deal.

Time will tell whether the GOP’s late-cycle spending will extend the business cycle substantially, but in the long run US policy will improve if more of these decisions are put on auto-pilot, removing the uncertainty of the political winds and the desire to spend at the least opportune times.

 

[1] The Obama administration stimulus plan cost around $850B in the end, including only the 2010 Stimulus measure and its implementation. Extension of Bush-era tax cuts and similar are not counted here, as these were extensions of existing measures, rather than new tax cuts or new spending as in the Trump administration’s recent moves.

[2] Many charts and news reports on the debt refer only to the publicly-held portion of the US debt, but when debts to the Social Security trust fund are included as in this data from the Federal Reserve, the US debt-to-gdp ratio already exceeds 100%.

The GOP Civil War on Taxes

Republicans love tax cuts, and both President Trump and Speaker Ryan have set their sights on lowering both personal and corporate income tax rates. But some Republicans also like controlling the budget deficit, while others favor defense spending or immigration control. How can the GOP cut tax rates, raise defense spending and immigration enforcement, and control the budget deficit? Here’s the heart of the problem: the federal government gets roughly $1.4T from income taxes, $440B from corporate income taxes and capital gains,¬†$1.1T from payroll taxes, and smaller amounts from other sources [1]. The tax plan under consideration will substantially cut the first two sources, without raising the other categories. How can such a tax plan be implemented without blowing up the budget deficit?

The evolving Trump-Ryan plan bridges this gap by introducing a new category: a border adjustment tax on imports. If all 2.7T in US imports were taxed at 20%, this could raise over $500B per year, providing a source for big tax cuts (though still not enough to pay for the tax cuts proposed). But there’s a problem with this idea – will 50 Republican senators vote for it?

The National Retail Federation has come out strongly against the plan, as have the Koch brothers, whose companies participate heavily in international trade. The Kochs are focusing their battle charge in 15 states where they may be able to sway Senate votes. Meanwhile, with retail giant WalMart strongly opposed, will the senators from Wal-Mart… err Arkansas be on board?

Hence we have a GOP civil war, pitting major exporters like Boeing, Oracle, and GE against retailers and other importers, and pitting nationalist Republicans versus traditional free-trade Republicans.

Trump and Ryan can only spare two votes in the Senate – will they be able to keep everyone on board? While the plan could stimulate US growth through tax cuts and favoring US production, it may also trigger a trade war that nullifies much of its benefit. There’s also the essential nature of the import tax – it is effectively introducing a new US consumption tax for the first time. Consumption taxes have been on the GOP radar for some time, as they tend to shift tax burdens down the income scale, and to reduce taxes on the wealthy. But is Trump’s base ready to pay an extra 40 cents at the pump every day, when many of them won’t see a huge tax cut [2]? Let the Republican tax civil war begin.

[1] The CBO provides a detailed breakdown of revenues here. I have combined corporate taxes and capital gains into one category, as both are taxes on capital.

[2] Roughly 50% of oil is still imported into the US, so a border adjustment tax could disproportionately increase oil prices.

A Tax Cut for All

With the 2001 tax cuts beginning to expire in a few years, perhaps it is time to revisit them. Those tax cuts, along with a subsequent tax cut in 2003, cost roughly $150 billion per year in lost tax revenue. Tax rates were cut across the board, with a drop from 15 percent to 10 percent in the lowest tax bracket, and a drop from 39 percent to 36 percent in the highest bracket. A myriad of other tax breaks including a cut in taxes on dividends and capital gains combined to make one of the largest tax reductions in years. Now, with the tax cuts set to expire in 2010, Democrats argue that they be allowed to expire to reduce the deficit while Republicans argue that they should be made permanent. A recent Congressional vote over a minimum-wage increase succumbed to this battle, as Republicans attempted to tie the repeal of the estate tax to a minimum wage hike.

There is room for compromise on this issue, where all Americans can enjoy a tax cut without increasing current structural deficits. A reduction in the lowest federal tax bracket (for income below $10,000) from 10% to 0% would provide $1000 in tax relief for every full-time American worker, from the richest to the poorest. The elimination of the lowest tax bracket would lift more Americans out of poverty than a hike in the minimum wage, since it wouldn’t have the adverse affects on employment that a wage floor can have. If developing nations like China and India can do without an income tax for the poorest in society, can’t America? One caveat: giving $1000 in taxes back to all 145 million American workers would cost $145 billion annually.

How can America pay for a tax cut even larger than the last round? For starters, since the lowest tax bracket would be eliminated, the Earned Income Tax Credit could be largely eliminated as well. The EITC rebates $40 billion per year to the poorest families in America, but adds a large regulatory burden for both families and the IRS by requiring taxpayers to claim the credit, with the IRS auditing them to ensure eligibility. Eliminating the EITC could help pay for a large chunk of lowest-bracket elimination while lightening the tax filing burden for a significant percentage of the population. Next, allow the upper tax bracket and estate tax reductions to expire in 2010, adding roughly $100 billion to government revenue. Finally, make permanent the 15% tax rate on dividends and capital gains, providing investment tax relief for the middle class and wealthy. The 15% rate on dividends and capital gains costs $5 billion to government coffers, but provides an incentive to the investing class to support the overall tax package.

All this leaves a neat compromise in which all Americans get a $1000 tax cut, and upper-middle class and wealthy Americans get to keep low investment tax rates in return for pitching in on broader tax relief. The elimination of the lowest tax bracket and the EITC would also simplify tax filing for millions of Americans, from poor working class families to the elderly and part-time workers as well. US mid-term elections take place tomorrow; if the Democrats take the House, this sort of tax cut would be a welcome new idea for their platform. If the Republicans narrowly maintain control, a broad-based compromise tax cut for all might be just the kind of legislation they need to break the legislative logjam. Any takers?