Cutting taxes by a few hundred billion dollars a year will provide a fairly strong economic stimulus, but it will also raise the annual federal budget deficit by about the same amount. These deficits, in turn, may push up the inflation rate, which would probably induce the Federal Reserve to continue tightening credit and raising interest rates. These actions by the Fed could cancel out the stimulative effect of the tax cuts.
The Trump Administration has proposed cuts to individual and corporate income taxes totaling $7 trillion over the next ten years. This, of course, is a wish list. Although it’s extremely unlikely that Congress will pass tax cuts totaling even half this figure, let’s next consider how these cuts will be paid for.
No matter what other measures Congress may enact, if massive tax cuts are enacted the annual federal budget deficit will rise by a few hundred billion dollars. Let’s look at three possible ways of holding down the rise in the deficit. The two tried-and-true ways are raising taxes, and cutting government spending. Later, we’ll consider a third measure – raising the rate of economic growth.
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Enact a border adjustment tax Congress has been considering imposing a “border adjustment tax” of 20% on U.S. imports, which is projected to raise over $100 billion a year in revenue. But strong opposition from retailers, other major importers, and consumer advocates has rendered this proposal dead on arrival.
Consumer groups object to higher prices, as do Walmart, Target, and other major retailers. While major exporters, especially large agribusinesses such as Archer Midland Daniels and Cargill would support this measure, it would likely cause our trade partners to reciprocate by imposing higher tariffs on American exports, possibly even setting off a trade war which all sides will lose.
Enact a corporate offshore profits repatriation tax
In 2004, the administration of President George W. Bush worked out a deal to repatriate hundreds of billions of offshore corporate profits, which were taxed at the bargain rate of just 5.25 percent. Hailed as a job creation program, most of the repatriated funds were used by these companies to buy back their own shares and raise dividend payments.
A few years later, President Bush’s chief economic advisors conceded that there was no evidence of any job creation. Still, it was a win-win deal: The companies were able to bring home hundreds of billions of dollars, and the U.S. Treasury collected tens of billions in tax payments.
Today, approximately $2.6 trillion dollars of untaxed profits of American corporations are being held off-shore. The three largest holders are Apple ($230 billion), General Electric ($119 billion}, and Microsoft ($113 billion). Although these profits were earned abroad – and were subject to foreign corporate income taxes – if this money were sent to the United States, it would still be subject to our 35% tax rate.
There is widespread support for another tax holiday, to enable large companies to bring home most of their overseas holdings. Although they might be taxed at a rate of as much as eight or ten percent, these corporations will probably repatriate most of their foreign holdings, thus providing the Treasury with a windfall of over $100 billion.
Cut government spending
Most of us agree that there is no such thing as a free lunch. So wouldn’t it be logical to begin to make up for the tax revenue shortfall by cutting the SNAP (food stamp) program? Shouldn’t the poor do their fair share to pay for the tax cut going largely to the rich?
But we can do a lot better than that. President Trump and many Congressional Republicans are calling for a cut in Medicaid funding of almost 50 percent by the year 2028.
Raise the rate of economic growth
Growing the economy by the three percent annual rate predicted by the Trump Administration would be a painless way of holding down the federal budget deficit, and even bringing our economy back to the good old days. In fact, we might not even have to raise taxes or lower government spending very much.
There are just two problems, at least from a historical point of view. First, our most rapid rates of economic growth were usually during recoveries from recessions. Since the new millennium, we have gone through two recessions – one of which was the worst we’ve experienced since World War II. And yet, over the last seventeen years, our economy has grown by more than three percent in just three years.
A second reason why we may not see a growth rate of three percent any time soon is because our economy is now at about full employment. (Most economists consider an unemployment rate of four percent full employment.) The unemployment rate in May was just 4.3 percent – the lowest it’s been in sixteen years. Rapid growth usually occurs when there is a large stock of unemployed resources which can quickly be brought back into production. Right now, there’s very little slack.
Still, it can be argued, however, that massive tax cuts will stimulate economic growth. But the resultant deficits will probably push up the rate of inflation, and the Federal Reserve will respond by continuing to restrict the rate of growth of the money supply, and raise interest rates. In effect, our stimulative fiscal policy and our restraining monetary policy will largely cancel each other out.
What are the chances that Congress will pass a tax reform bill – or even a bill that just cuts taxes, without much pretense of tax reform? Right now, they’ve got a full plate. The Senate is only beginning to consider the Affordable Care Act passed by the House, which would repeal and replace Obamacare. And then, both houses must wrestle for the federal budget for fiscal year 2018, which begins on October 1st. Congress will be on vacation for the month of August, so it’s unlikely that much progress will be made on tax reform until at least the fall.
Steve Slavin, Ph.D., is Associate Professor of Economics at Union County College, Cranford, New Jersey. Dr. Steve Slavin has written sixteen math and economics books, including a widely used introductory economics textbook now in its eleventh edition (McGraw Hill) and The Great American Economy (Prometheus Books) due out in August 2017.