I need to disagree with the editors of the Wall Street Journal on this one. They write, in criticism of President Trump’s recent remarks on abolishing FICA:
Does anybody in politics understand tax policy these days? The Biden-Harris Democrats want to raise tax rates to Thomas Piketty French socialist levels. Republicans want to cut taxes, but they want to do so for specific groups to buy their votes. They’ve all lost the growth plot.
Mr. Trump’s tax fumbling is especially disappointing because his 2017 cut in tax rates was the policy foundation for the strong pre-pandemic U.S. economy. But so far in this campaign he’s proposing hugely expensive tax cuts for different voting groups that won’t do much for growth.
My specific disagreements are:
- That there was a boom at all between 2017 and the 4th quarter of 2019 and
- That cuts in the personal income tax had much to do with GDP growth
Courtesy of the St. Louis Federal Reserve here’s a graph of GDP growth:
and here’s a graph of private investment:
What I see in both of those graphs, noisy as the BI graph is, is a continuation of trend. That’s even clearer when you look at GDP in constant dollars:
It’s even more obvious when you look at real personal consumption expenditures:
Back in 2017 I argued in favor of the cut in the corporate income tax but against the cut in the personal income tax and my reasoning at the time has been completely borne out. The really interesting thing in the graphs above is that the Trump tax cuts did not produce more inflation than they did. Could that be because of the shutdowns?
If your plan is to increase GDP by injecting money into the economy (and producing inflation), why does it matter whether (from an economic standpoint) whether the money is going to the elderly or to the highest income earners?
Cowen recently cited a study which through some moderately complex number manipulation claimed to show that the tax cut law did show a small increase in investment. It was much lower than predicted by the Trump admin and IIRC it didnt contribute much to growth. I continue to think that sometimes tax cuts can lead to some growth but it’s rarely as much as claimed by their advocates and that the effects are small compared with many other effects in the economy. That same Cowen study claimed that the depreciation changes that came along with the tax cuts had a larger effect than the tax cuts.
Steve
Dave Schuler: why does it matter whether (from an economic standpoint) whether the money is going to the elderly or to the highest income earners?
Tax cuts for the elderly are much more likely to be immediately spent, increasing demand. Tax cuts for the wealth are often saved or used to pay down debt. Savings do increase available capital for investment in the economy, but have a generally much lower stimulatory effect because there is no reason to invest unless there is demand.
As a rule, a stimulus only works if there is slack in demand, otherwise it results in inflation. Borrowing for stimulus will compete against private investment unless there is slack in investments. Hence, stimulus during expansions (allowing for lag) is generally contraindicated.
What Keynes taught was pretty much the reverse of that. You can stimulate demand with (deficit-based) stimulus as long as there is excess aggregate product. Without unused productive capacity stimulus produces inflation i.e. willingness to pay increases and prices rise.
That you can stimulate demand is pretty much axiomatic: give somebody $5 and they’ll either spend it as long as there’s something on the shelf to buy or save it. The reason that President Biden’s stimulus package produced inflation was not that there was insufficient demand but that there were no unused productive resources.
The reasons that President Trump’s cut in personal income tax rates did not produce as much stimulus as assumed was that the recipients saved it, i.e. either stuck it in the bank or bought stocks or bonds. Buying stock does not become business investment unless a) it’s an IPO and b) they take the money and expand facilities or otherwise invest it in something non-financial. That’s our problem. The stock market is too distinct from the real economy.
I’m sure I’m going to get an argument about that but let’s use an example. I buy 10 shares of Worldwide Widget Stock. If I buy it directly from Worldwide Widget, they might invest it. If I buy it from the secondary market, they can’t. Even when I buy it from Worldwide Widget they can invest it or use the money to pay dividends, etc.
Dave Schuler: You can stimulate demand with (deficit-based) stimulus as long as there is excess aggregate product.
The Keynesian phrase is “insufficient aggregate demand”, that is, insufficient compared to productive resources. The government can then supply the demand, either directly, or through stimulus.
Cowen published a piece recently looking at the effects of the tax cut law. Through a lot of number manipulation they claimed to show a small increase in business investment, however it was much smaller than predicted by the Trump admin and the effects of the depreciation changes in the law had a larger effect. That said, I think cumulative evidence and basic reasoning suggests tax cuts have some positive effect on investment and growth but experience shows that it is small and far outweighed by many other factors in the economy. Still think we should do away with corporate taxes as they are such a source of corruption.
Steve
I think if one looks at real median household disposable income (https://fred.stlouisfed.org/series/MEHOINUSA672N); the answer is there was a boomlet from 2017 to 2019; I argue it was between 2015 to 2019 based on analogies with the graph of 1990s and how people perceived the economy coming out of the early 90’s recession.
That’s basically my point.
CuriousOnlooker:
I’m skeptical that was the result of the cut in the personal income tax rate. I think it’s much more likely it resulted from reduced immigration.
“..but have a generally much lower stimulatory effect because there is no reason to invest unless there is demand.”
You don’t have the slightest clue as to whether that is true or not. Its been studied to death. The results are imperfect and often times rigged. The only thing anyone really knows is that a dollar in the pocket of the private sector is almost always better allocated than by the public sector.
“The reason that President Biden’s stimulus package produced inflation was not that there was insufficient demand but that there were no unused productive resources.”
Almost certainly true. So the policy failure was to slop money into the economy and not adopt policies that increased productive capacity. Most directly: energy. Its everywhere.
I think steves comment is probably largely true. We could debate all night about the magnitude of the effect of tax cuts.
But I find it odd that people almost always acknowledge that cost increases affect them and their decisions: rent, time financed assets (interest rates), food costs, gas and electric…….. Yet, for some reason the cost increase called taxes is so politicized that people just deny that THAT cost increase harms. Very, very strange.
Dave, I don’t necessarily disagree with you on the relationship between the tax cut and the boomlet. My point is there was a boomlet.
I’m sure Trump’s distractors would argue it was due to the Obama administration or it just took that long to recover from the GFC. Trump would say it was due to his stewardship while he was in the White House (tax reform and tax cuts, immigration, trade deals, deregulations or at least less new regulations, foreign policy).
Drew: You don’t have the slightest clue as to whether that is true or not. Its been studied to death.
Yes, and the vast majority of studies and historical experience show how and when a stimulus works, which is why nearly all countries implement stimulus during economic downturns.
I don’t think any of this speaks well of the tax policy of either party. Both believe in delusions that tacitly support the status quo. The only thing they really disagree about is taxes on businesses and the “rich,” which Democrats currently define as about $400k in income – IOW, the top 2-3%.
Democrats are selling the lie that you can have robust social welfare programs funded only by the 2-3%. Republicans keep selling the lie that tax reductions don’t increase the deficit and magically produce more growth.
The problem is really us – the American people want lots of government largess as long as someone else is paying for it.
What ended it is much more clear, COVID.
What President could have done differently with a better economic record?