The 2017 Tax Cut Still Won't Pay for Itself
The 2017 tax law, pushed by the Trump administration and passed through a Republican-controlled Congress, has boosted economic growth and will continue to do so over the coming years. The added growth will increase the incomes of millions of American households. The law did this, in part, by rationalizing a corporate tax system that was badly in need of reform and which previous Democratic and Republican administrations had failed to fix. These are real achievements that Republicans can rightly highlight when campaigning for office in 2020 and beyond.
While the tax law is clearly pro-growth, it would have been better if Congress had paired it with additional base-broadening adjustments or spending reforms to prevent a large increase in the government’s already high debt burden. Even before Congress passed the tax cut, the federal government was running large and growing deficits, and projections from the Congressional Budget Office (CBO) showed federal debt rising to levels well beyond the historical norm. The tax cut added to the problem.
But some advocates of the 2017 law don’t want to concede this point. They claim the tax cut won’t widen the government’s future budget deficits because an expanded economy will generate sufficient additional revenue to offset the losses from lower individual and corporate tax rates. They compare CBO’s GDP projections before and after passage of the tax law and suggest that the difference is due entirely to the tax changes. They then apply the ratio of federal tax receipts to the added GDP growth and claim this is revenue that would not be coming into the government if the tax cuts had not passed in 2017.
CBO has now issued a short analysis clarifying the effects of the tax law on the GDP growth revisions since 2017. Not surprisingly, CBO doesn’t think the tax cut will pay for itself.
According to CBO, the agency’s forecast of cumulative GDP (in nominal dollars) over the period 2017 to 2027 is $7.2 trillion higher in its current projection (released in January) compared to its forecast from two years prior, in January 2017. CBO says that the tax law boosted cumulative GDP over this period by $2.3 trillion, or about one-third of the total change. In addition to the tax law, Congress and the president also agreed to a substantial increase in defense and non-defense appropriations in 2018 and 2019, which will then be carried into future years. CBO estimates these spending increases also boosted aggregate demand, and thus also GDP. This added spending accounted for $1.3 trillion of the change in cumulative GDP over the 2017 to 2027 period, or nearly one-fifth of the total.
CBO also revised its GDP projections to account for changes in economic performance detected in the Department of Commerce’s National Income and Product Accounts (NIPAs) in 2017, before the tax cut. The economy began growing at a faster pace in 2016, probably for a variety of reasons, and came into 2017 with more momentum than was reflected in CBO’s January 2017 projection. The Trump administration added to this momentum by coming out the gate in January 2017 with an aggressive deregulatory agenda, which boosted business confidence and increased investment activity. Finally, some of the growth that began in 2017 might be attributable to anticipation of major tax changes, although it was hardly a foregone conclusion that a tax cut would emerge from a Congress that had failed in mid-2017 to repeal and replace the Affordable Care Act.
CBO’s confirmation that the 2017 tax cut is boosting growth, and that this growth is offsetting some of the revenue loss from rate cuts, is a substantial victory for the law’s advocates. On a static basis (that is, without taking into account faster growth), CBO estimates the tax cut, and associated borrowing costs, will add $2.3 trillion to federal deficits over the period 2018 to 2028. When the added growth from the tax cut is included in the calculation, the deficit increase falls to $1.9 trillion over the same period. Put another way, the boost to growth reduces the revenue loss by about one-third.
Claiming the tax cut is paying for itself is playing a losing hand. All current data point to a rapidly deteriorating fiscal outlook, which runs directly counter to the contention that the tax cut is budget neutral. From 2013 to 2017, federal revenues increased at an average annual rate of 4.5 percent. In 2018, the federal government took in $3.329 trillion in receipts, or just 0.4 percent more than in 2017. In the first quarter of 2019, federal receipts are still flat, with no revenue growth over the first quarter of 2018.
Citing GDP growth to defend the tax cut could backfire when circumstances change. There are regular and large shifts in ten-year nominal GDP projections from both CBO and the Office of Management and Budget (OMB), and those adjustments don’t always point toward faster growth. Sometimes GDP growth is revised downward, with a small adjustment in the near-term leading to a large adjustment over ten years. U.S. GDP might grow more slowly than expected in coming years for any number of different reasons that have nothing to do with the tax law, including: changes in monetary policy; enactment of legislation that cuts spending in the near-term; political confrontations that disrupt government operations; trading disputes; changes in the growth rates of major international markets for U.S. exports; and international conflicts. If, in a future forecast, U.S. GDP is projected to grow more slowly than CBO currently expects, it is doubtful that advocates of the 2017 tax law will be willing to assign all of the slowdown to lower growth effects from tax cuts.
Proponents of the 2017 tax law should be celebrating the emerging consensus that the law strengthened the U.S. economy instead of picking a fight over its fiscal effects that they are sure to lose. Because there is no denying that the fiscal outlook is dismal. Unless Republicans really think a spontaneous surge in revenue is just around the corner, the prudent course would be to advance the spending reforms and tax loophole closers that would improve the budget outlook and increase the likelihood that the tax law will survive beyond the Trump presidency.
James C. Capretta is a RealClearPolicy Contributor and a resident fellow at the American Enterprise Institute.