Tax Reform, Growth and the Deficit

The Editorial Board Wall Street Journal Nov. 26, 2017 

A U.S. growth rate of 1.9% will never balance the federal budget.

Start with the fact that the GOP budget outline allows for a net tax cut of $1.5 trillion over a decade on a statically scored basis thanks to a deal brokered by Senators Pat Toomey and Bob Corker. Democrats and their media chorus are using that number to claim that reform will bust the budget and add to the federal debt. This comes with ill grace from people who cheered Barack Obama’s doubling of the national debt in eight years, but it’s also overwrought.

The actual budget hole is smaller than $1.5 trillion because the GOP budget is scored on a “current law” baseline. This assumes that tax breaks that are “current policy” will expire and more revenue will flow to Treasury. This is worth more than $400 billion over 10 years, which means the budget “hole” is closer to $1 trillion out of the $43 trillion the Congressional Budget Office projects in revenues over the next decade. In other words, this is a modest net tax cut even assuming no additional economic growth.

CBO’s estimates are inherently speculative because no one knows when the next recession might hit or what some future Congress might do. But CBO has typically underestimated the growth and revenue feedback from tax cuts. A classic example is the 2003 cut in the tax rate on capital gains. Dan Clifton of Strategas Research notes that in January 2004, eight months after the tax cut passed, CBO predicted $215 billion in capital-gains revenue through 2007. The actual figure? $377 billion. CBO underestimated economic growth and how much investors would cash in their gains.

CBO’s roughly $43 trillion revenue estimate also depends on a projection of average economic growth of 1.9% a year. But the U.S. economy has never grown that slowly for so long. CBO says that every 0.1% increase in GDP adds about $270 billion in revenue over 10 years. That means a mere four years at 3% growth—the U.S. historical norm—could fill a $1 trillion hole. An average growth rate of even 2.4% over the decade would more than fill the hole.

Nearby we reprint a letter from some of the country’s most distinguished economists making the case that the House and Senate reforms will significantly raise U.S. growth potential. The biggest boost comes from the reductions in the tax burden on capital, which should increase investment and thus growth.

One of the signers, Larry Lindsey, predicted in our pages this fall that economic growth under the GOP plan would accelerate to 3.2% for three to five years and then settle at 2.5%. The Tax Foundation predicts the Senate plan will produce more than $1 trillion in revenue, in part thanks to an investment catalyst from immediate capital expensing in the first year.

The left ignores all this and flogs as unrefutable whatever emerges from the Joint Committee on Taxation. But Joint Tax assumes the U.S. is a partially “closed” economy with little access to global markets. Its models assume that higher deficits will “crowd out” private borrowing and thus drive up interest rates and offset the growth impact of the tax cut. Yet a major goal of the tax reform is make the U.S. more competitive as a destination for foreign capital, and interest rates in a global capital market will be determined by far more than a modest increase in the U.S. budget deficit.

Another false charge from the left is that the GOP bills are merely a tax cut without any reform. But the bills eliminate trillions of dollars in loopholes, such as the state and local tax deduction. The House bill caps the mortgage-interest deduction at $500,000.

Also on the chopping block are business carve-outs—including cuts in the deductibility of interest—that are used to pay for lower business tax rates. We’d like to see every loophole eliminated, but this really is the most far-reaching business-tax reform since 1986.

One fair objection is that the true deficit impact is partially hidden because the Senate’s individual tax cuts expire after 2025, though everyone assumes Congress would extend them. This fudge is driven by the Senate’s mistake in doubling to $2,000 the child tax credit, which does nothing for growth and is thus a deadweight revenue loss to Treasury.

This is a sellout to Senators Marco Rubio and Mike Lee, as well as to the income distribution tables and the class-war left—not that it is muting the critics. If the budget hawks want to reduce reform’s deficit impact, the child tax credit’s size and income phaseout of $500,000 should be their targets.

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The question Senators need to ask themselves in the end is whether this reform, all things considered, is a net benefit for the country. We think it is—not least because it is a vote of confidence that better policies can restore America’s traditional economic vigor. Democrats and their media friends have given up on that score, concluding that we are doomed to “secular stagnation” and that our politics must devolve into a brawl to divide up the spoils of whatever meager growth we can muster.

That is not the country we have known and it is an America that would be much diminished and harsher. Republicans need to decide if they still believe America can prosper again, or if it is doomed to the slow growth and stagnant wages of the last 11 years.