Tax plan packs punch but could bruise the economy
Long-term effects would strain U.S., experts say
The Republican tax-cut package unveiled Thursday would give the U.S. economy a big sugar-high next year. But the inevitable comedown is likely to follow, economists say.
By reducing taxes for households and businesses, the reform would boost consumer spending and business investment in the short term, lifting economic growth. But with the economy at full employment, it also would strain its capacity to respond to the surge in activity, stoking faster wage growth and inflation. That will lead the Federal Reserve to raise interest rates more rapidly, discouraging home purchases and consumer and business borrowing, says Mark Zandi, chief economist at Moody’s Analytics.
Interest rates also would rise because the plan would reduce federal tax revenue by $1.5 trillion, swelling the deficit and forcing the government to borrow more to finance spending.
“It juices growth in 2018, but it likely reduces growth in the early part of the next decade.” Zandi says. “My sense is that 10 years from now, the economy will be no bigger than it would have been.”
Under the plan, the economy would grow about 3% next year, up from 2.2% under the status quo, Zandi says. He says the economy would add an additional 800,000 or so jobs in 2018; Greg Daco, chief economist at Oxford Economics estimates a more modest gain of 600,000.
But while higher interest rates would slightly dampen activity next year, they would have a bigger impact in 2019, leaving a net boost to growth of just three-tenths of a percentage point, Daco says. By 2020, the higher rates would overwhelm any remaining stimulus from the tax reform, resulting in a net drag on economic growth of about a half a percentage point, Daco says. And Zandi says the economy would lose jobs that year
Gary Hufbauer, an economist and senior fellow at the Peterson Institute for International Economics, doesn’t believe the increased economic activity will stir inflation and require faster rate hikes that offset the gains.
“I don’t buy that,” he says. For example, he says, a legacy of the recession of 2007-09 is that many Americans are working part time even though they prefer full-time jobs, while many discouraged workers remain on the sidelines. That’s a surplus labor supply that can contain wages and inflation, he says.
White House officials, meanwhile, have said the plan won’t balloon the deficit because the stronger economic growth will bring in more tax revenue, allowing the blueprint to pay for itself.
“It juices growth in 2018, but it likely reduces growth in the early part of the next decade.” Mark Zandi chief economist, Moody’s Analytics
Zandi and Daco, like many other economists, are skeptical. Here’s a look at how the plan could affect various stakeholders in the economy.
The big winner
Corporations: The corporate tax rate would fall from 35%, highest among industrialized nations, to 20%, though certain deductions, such as corporate interest payments, would be eliminated. Still, it should instantly make the U.S. more competitive in the race to draw manufacturers and other multinationals. “The U.S. would definitely be a more attractive place to do business,” Hufbauer says.
Also, businesses could write off the cost of new equipment immediately rather than over five years, sparking more business investment that increases productivity.
Gains at both ends of the spectrum
Low- and middle-income Americans: Among households, this group should gain the most. Most of them don’t itemize their deductions and the plan doubles the standard deduction — from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples. It also increases the child tax credit from $1,000 to $1,600. Those positives should more than outweigh the negative of eliminating personal tax exemptions. Low- and middle-income Americans tend to spend most of their earnings, and so their gains should bolster consumption.
The wealthy: Upper-income households will benefit significantly because the plan would exempt many from the estate tax on inheritances and eliminate the alternative minimum tax that some wealthy Americans pay. Yet these perks will not provide a big economic boost since the wealthy tend to save, rather spend, their marginal income gains.
Squeezed in the middle
Upper-middle-income households: While some would benefit, many would be worse off because the plan caps the mortgage interest deduction, and eliminates deductions for state and local income taxes and medical expenses. The doubling of the standard deduction likely would not make up for those losses, Zandi says. “Upper-middle-income households are going to get dinged the most,” he says. But those changes likely will not significantly affect their spending, he says.