Any discussion of fiscal reform must start with a truth that is seldom heard. The purpose of taxation is to generate the revenue needed to pay the government’s bills. In the face of rising deficits, even in good times (leaving no room for an emergency), either the government’s bills must be cut or the pressure to raise taxes to avoid a debt crisis will become irresistible. Thus, fiscal reform is necessary to prevent the undoing of the tax cuts. It is time for fiscal conservatism to regain its prominence.
By William R. Hawkins l March 7, 2018
Friday, December 22, 2017, President Trump signs the biggest tax cut legislation into law since President Ronald Reagan
The campaign to win public support for the Tax Cuts and Jobs Act (TCJA) rested heavily on the first element of the bill’s name: tax cuts; and then for the middle and working classes. By making small changes to rates while doubling the standard exemption, plus extending a few other benefits such as doubling the child tax credit, the bill gives the typical family of four earning the median income of $73,000 a tax cut of $2,059.
While this is not the “mere crumbs” Democrat House leader Nancy Pelosi (D-CA) asserted, to general derision, it is not sufficient to generate the kind of economic stimulus the Trump Administration needs to “make America great again.” Tax rates today are not what they were when President Ronald Reagan made his major tax reforms over thirty years ago. Now, legislation can only make minor adjustments in the across-the-board rates, if they intend to keep any eye at all on revenue and the budget deficit.
The real teeth in the Tax Cuts and Jobs Act also involved tax cuts, but they were targeted at business firms with an eye to creating domestic jobs. There is far more “bang for the buck” from this approach.
Cutting the corporate tax rate to 21% from its previous 35% was the most important piece of the legislation.
A study by the nonpartisan Congressional Budget Office released a year ago found that the U.S. corporate tax “was 10 percentage points higher than the average…of the top rates in the other G20 countries.” President Trump did not get the 15% rate he initially proposed, so the U.S. corporate tax is not the world’s lowest, but it is in the low end of the range, making America a more attractive place to maintain and expand productive activity. And, to further support such endeavors, the TCJA allows businesses to immediately write off the full cost of new equipment, a vital reform in a time of rapid technological innovation. Improved productivity is the only true foundation for higher wages.
The cuts in business taxes could not have won public support if offered alone; the pot had to be sweetened with cuts to individual tax payers which increased the “cost” of the bill in terms of lost tax revenue. Even then, liberal critics spread doubts that the bill would benefit anyone other than “the rich.” With take home pay up in February as tax cuts took effect, combined with the publicity that has accompanied the bonus payments and wage hikes many prominent corporations (400 and counting) initiated after the TCJA became law, the tax cuts look like a political winner for the Republicans. Indeed, according to a February 7 report by Gallup, there are only seven states whose residents still believe the economy is in trouble; all solid Democratic states whose own high tax/high spending policies are a drag on the boost Federal policies are giving to the national economy.
The Gallup survey also put the lie to the argument made by liberals that the current growth spurt is the result of momentum built up during the Obama Administration. According to Gallup, people in every state saw the economy in negative terms 2008-2013; 49 states continued to be pessimistic in 2014 and 46 states continued the gloom in 2015. The turn-around today reflects what Gallup cites as: “the nationwide improvement in economic confidence that has occurred since the 2016 presidential election.”
Economic fundamentals and business confidence were up before the TCJA was passed due to reforms the public didn’t see; the decrease in regulations ordered by President Trump. These are also targeted measures. So, what more can be done to reform Federal policy to promote national economic growth? The most important thing would be to change perspective, from tax cuts to fiscal reform (focused on the budget as a whole). According to Trump’s own Office of Management and Budget, tax revenues out to 2023 will run about one percent of GDP lower than they have averaged over the past twenty years. Spending will also be lower than the long run average, but the deficit will remain a major problem because the gap between spending and revenue will widen.
Deficits rise and fall with the business cycle, increasing during recessions and falling when the economy is running strong and expanding the tax base.
The Trump stimulus from tax cuts and deregulation is predicted to raise the national growth rate to 3%, maybe more, which should drive down the deficit. By historic standards the annual deficit should fall below 2% of GDP, perhaps close to 1% during the boom years. Yet, the OMB projects deficits of 4.7% of GDP in 2019 falling only slowly to 3.0% by 2023. Indeed, the 2019 deficit, in a year expected to show full employment, will be the same as the 1992 deficit which was a year of mild recession that spawned the iconic phrase “it’s the economy, stupid” and cost President George H. W. Bush re-election.
The OMB projection has spending running slightly higher than 20% of GDP, whereas the long- term trend during normal times is to run somewhat less than 20%, perhaps even down to 18.5%. A reduction in spending of about 2% of GDP (about $400 billion in 2018) would not balance the budget but would bring the deficit as a share of the national economy back within normal parameters. Without such spending cuts, it may be very hard to renew the individual tax rate cuts in the TCJA which will expire in 2025. And should there be a change in party control of the Congress or White House sooner than that, the deficit will give the Democrats a more popular reason to raise taxes than just “soaking the rich.”
A debate over how to control and reduce spending will force a hard look at what are the legitimate functions of government. Politicians have attempted to avoid this tough issue of setting priorities by allowing a loose fiscal policy or indulging in “across-the-board” restraints like the Budget Control Act of 2011. This dreadful bill started to impact budgets in 2013. Sequester dumped half of the mandated cuts on the military even though defense spending makes up less than a quarter of the total budget. Entitlement spending was not touched and remains out of control. It was an Act of pure irresponsibility, avoiding the decisions necessary to restore fiscal order.
President Trump’s priorities for higher spending are defense and infrastructure, both traditional functions of government. Indeed, providing for national security is the primary duty of the Federal government. Sequester has hollowed out our armed forces, especially air and naval units which are critical for meeting the demands of great power competition as detailed in the administration’s National Defense Strategy. And the deterioration of America’s transportation and communication networks has been a scandal for decades. More spending is justified on these programs and should not be blocked because of the deficit. The proper place to look for, and correct, the causes of the deficits are in other parts of the $4.1 trillion (and growing) Federal budget. Surely, within a budget larger than the entire economy of Germany, savings can be found – and must be found, as the numbers will only worsen without fiscal reform.
The OMB projects a deficit for 2018 of $842.6 billion, the highest since 2012. It further projects annual deficits running over $900 billion out to at least 2023 as annual Federal spending increases by over a trillion dollars during this period.
The TCJA may stimulate economic growth, but not enough to narrow a budget deficit driven by spend-thrift politicians. The deficit will become a drag on the economy as interest rates rise and capital is diverted (crowded out) from productive investment into funding the government debt. So, the real battle to put the nation’s finances on a sustainable basis has barely started.
Any discussion of fiscal reform must start with a truth that is seldom heard.
The purpose of taxation is to generate the revenue needed to pay the government’s bills. In the face of rising deficits, even in good times (leaving no room for an emergency), either the government’s bills must be cut or the pressure to raise taxes to avoid a debt crisis will become irresistible. Thus, fiscal reform is necessary to prevent the undoing of the tax cuts. It is time for fiscal conservatism to regain its prominence.
William R. Hawkins, a former economics professor and Congressional staffer, is a consultant specializing in international economics and national security issues. He is a contributor to SFPPR News & Analysis, of the Conservative-Online-Journalism center at the Washington-based Selous Foundation for Public Policy Research.