In the Nation's Interest

Trump’s Tax Reform Is A Cliff Dive into Unknown Waters

President-elect Donald Trump's economic team has been very clear that tax reform is the key to raising inflation-adjusted economic growth to a sustainable 3 percent to 4 percent range each quarter. The tax cut for middle-income taxpayers will be huge, they say, and the corporate income tax rate will be cut enormously, from 35 percent to 15 percent.

Steven Mnuchin and Wilbur Ross, Trump's choices to lead the Treasury Department and Commerce Department, are betting that all the money lost from these two tax cuts will come back because of a big increase in jobs, wages, and therefore, personal income tax revenues. This will all be according to dynamic scoring, which is alleged to capture the economic growth benefits of the tax program.

Old-think Washington sticks-in-the-mud, including myself, are skeptical. Here's why.

First, the lower corporate tax rate will not create a huge number of jobs as claimed.

There are still big differences in wage costs between the United States and many of our current supplier nations. Low-value manufacturing, less-skilled-than-U.S. foreign labor is often good enough. Shipping technology has improved and fuel costs are low, making shipping goods less costly.

Taxes are just one element of the equation. Our foreign competitor firms and their governments surely won’t give up without a fight. They will redouble their efforts to cut their costs, and their governments will respond to our tax cuts.

Second, we do not have the workers to fill all of those hoped-for new jobs.

Sure, it has been fashionable to talk about "real" unemployment rates of 15 or even 40 percent. But we can't count Granny in the senior center, and Junior away at college, as plausible new entrants into the labor force. We need to recognize that the baby-boom generation, which has been a big and reliable component of our workforce, is retiring in large numbers (the birth class of 1946 turned 65 almost six years ago).

That drag of the baby boom’s retirement on the growth of our work force directly reduces the potential growth rate of our economy. The Trump team would point to the growing number of part-time jobs as a workforce resource. But most of the growth of part-time employment in the last decade has been among people who want to work part time for a variety of personal reasons.

Surely and admittedly, there are some people who dropped out of the work force during the financial crisis and are still on the couch. But their numbers are small and getting smaller because many of them are getting older, and their skills are growing more and more stale.

Finally, there is the risk the Trump team is wrong.

The team's self-described “largest tax change since Reagan” will happen because passing tax cuts in Washington is about as hard as handing out chocolates in a school play yard. It will happen in a very different world from what The Gipper faced.

When Ronald Reagan put forward his tax cuts, the federal government's accumulated debt was 25 percent the size of the nation’s gross domestic product (GDP). For context, when Reagan and George H.W. Bush left office, it was 50 percent.

In 2001, when George W. Bush proposed his tax cuts, the debt-to-GDP ratio was 33 percent. When he left office, it was 75 percent. Today, the debt-to-GDP ratio still rounds to 75 percent, triple what it was for Reagan.

These three successive "supply-side" tax cuts are like cliff diving into waters you don’t know and haven’t checked, but first from 25 feet up, then 33 feet, and now 75 feet.

The risk gets larger each time, and at today's debt level it is profound. After all, the European Monetary Union’s founding treaty said that a 60 percent debt-to-GDP ratio should be the limit.

The Trump tax team is starting from well above that level. The world's financial markets see and know that. The team could well take one more big jump in our debt load as the last straw, and it wouldn’t be pretty.

If supply-side economics doesn't work this time – and the old Washington fuddy-duddy economists have some good arguments on that point – this next cliff dive could end in a very hard landing.

 

This column was originally featured in The Hill.