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Are the Tax Cuts Working?

In this new age of instant communication, and its associated desire for instant gratification, people also expect instant answers. So no one should be surprised that the 2017 tax cuts, surely the major legislative achievement of the current Congress and Trump administration, will be watched with bated breath. Did the tax cuts pay for themselves? Are we there yet? Sorry, but we need just a little bit of patience.

You can read all of the opinions you want. A major U.S. financial newspaper, which shall remain nameless (just kidding), has weighed in already. I have my own opinion, after going through this kind of cycle of major tax changes three times before, and I would be happy to share it. No one knows the future, and the one thing that we all should know for sure is that we haven’t reached the future yet.

Here are two reasons why it is far too early to make a call on the economic efficacy and budget impact of the 2017 tax cuts. First, not a single full year tax return has been filed under the new tax law. Not one. (Some fiscal year taxpayers, which are usually corporations, may have used the new law for a quarter or two.) Many taxpayers are still probably struggling to grasp how the puts and takes of the new tax law, including the cutback of state and local tax deductions, as well as the elimination of some personal exemptions, will affect them on the whole.

What we do have so far is final tax liabilities paid by most taxpayers on calendar 2017 incomes. The optimistic stories thus far, for example, place essentially their full weight on tax revenues on final settlements paid in April 2018 versus those paid in April 2017, in other words, on taxes on calendar 2017 incomes versus those on calendar 2016 incomes. But do you really want to bet the farm on the economic impact on all of calendar 2017 income of a tax bill passed by Congress and signed by the president last December? Seems like a stretch worthy of a Hall of Fame first baseman.

Moreover, any high income individuals will actually make their final tax payments on their calendar 2017 incomes this October, shortly after fiscal 2019 begins. So even the federal government books for fiscal 2019 will depend in part on income from before the new tax cuts were enacted. That is part of the reason why we need to look patiently and carefully at the budget numbers before we leap to any conclusions.

Second, it also matters just where in the economy you expect supposedly increased income and tax revenue will come from. The 2017 tax cuts are pumping a lot of money into the economy in calendar 2018, therefore leading to additional consumer spending. For an economy that has been recovering from the financial crisis for a decade now, and that had achieved something approximating full employment even before the tax cuts became law, that burst of stimulus from federal government dollars has few historical precedents.

Usually, when the economy is strong, budget policy is designed to prevent overheating, and works to reduce the budget deficit. The 2017 tax cuts push in exactly the opposite direction of what the economics textbooks tell us to do. The last time budget policy stimulated a full employment economy was in the late 1960s, through the costly expansion of the Vietnam War. The resulting inflation was not pretty.

To slow that accelerating inflation, the Federal Reserve of the time raised interest rates. Interest rates today are still quite low, but if any signs of inflation should arise, expect the Federal Reserve to employ the lessons of the 1960s, raise interest rates even more than anticipated, and make sure that price increases do not get out of hand. Such increases in interest rates will both cut down on economic growth and increase the Treasury Department debt service costs, making the budget problem even worse.

If the 2017 tax cuts are to strengthen the economy over the long haul, the muscle needs to come from a continuing growth of business investment, not a one time hit of consumer spending. Investment has shown signs of life, but that could be just businesses pulling forward already planned expansion because of the big corporate income tax cuts. Economic staying power will require continuing investment growth into future years. Will it happen in the face of Federal Reserve interest rate increases? Stay tuned.

As of the enactment of the tax cuts last year, the budget outlook was bad, and worsening. Even if the tax cuts literally pay for themselves, the budget outlook will still be bad, and worsening. If old fashioned economic analysis proves to be right, and the tax cuts add to an already unsustainable growth of the public debt, there will be hell to pay. The tax cuts were, as the renowned late Senator Howard Baker put it in 1981, a riverboat gamble. Today, that is a riverboat gamble with even higher stakes.

Joseph J. Minarik (@JoeMinarik) is senior vice president and director of research at the Committee for Economic Development. He served as chief economist at the White House Office of Management and Budget for eight years under President Clinton. He previously worked with Senator Bill Bradley of New Jersey on efforts to reform the federal income tax, which culminated in the Tax Reform Act of 1986. He is coauthor of “Sustaining Capitalism: Bipartisan Solutions to Restore Trust & Prosperity.”