Do tax cuts make us richer?
Yes. At least in the short term.
Will tax cuts make America great again?
Umm...let's examine that.
Congress is working on a massive tax reform bill. Everyone gets a tax break under the new bill. (It won’t be equitable but that’s another story.) Citizens can spend that bit of extra dough that they would have given to the government on other goods and services like a new toilet or taking a trip to Branson, Missouri. As more and more citizens make more and more purchases they wouldn't have otherwise made the economy starts to grow. Plumbers and entertainers now have more work. We have new toilets and entertainment. Yay! Everyone's a winner! Right?
Yes and no.
True, I and my fellow Americans have new toilets and can afford to go to Branson, Missouri. But what about the other part of the bargain? What about the solvency of the United States of America? When asked about the national debt during the third presidential debate then-candidate Trump and secretary of state Clinton both cited growing the economy as the path to putting America back in the black. Mr. Trump said: "I'm cutting taxes. We're going to grow the economy. It's going to grow in a record rate."
President Trump is making good on the first part of his claim. But does the second part hold true? Is it possible to grow our way out of debt? I've done some (very rudimentary) calculations to examine this.
Scenario #1
In the first scenario I wanted to find out how long it would take for the government to break even if the economy grew steadily at 4%. 4% growth was the magic number that Mr. Trump cited during the debate. (He said we could even go as high as five or six percent but more on that later.) 4% is not a wild claim. We had several years of consecutive 4% GDP growth in the 90s. This scenario also assumes government spending remains steady at 4 trillion USD per year and federal revenue as a percentage of GDP is a constant 17% (Since 2000 revenue has averaged 16.7%. I rounded up.) This is what it looks like:
In this optimistic projection (and by optimistic I mean unrealistic) we break even somewhere between 2025 and 2026. (And we pay off the whole national debt by 2040. That's right folks! Just 23 eeeasy installments of 4% growth per year!) There are, of course, some problems with this scenario. The first is government spending remaining constant. It's grown by more than 125% since 2000. The second is the average revenue sticking at 17% of GDP. I'm nowhere near smart enough to calculate what that number will be but I'm guessing that since the government is collecting less taxes that number will go down. So let's look at another scenario.
Scenario #2
In this scenario government spending increases by a modest 1% per year. That's not very realistic but I want to keep these estimates conservative. Federal revenue as a percentage of GDP remains at 17%. Again, not very realistic but like I said earlier, I'm not smart enough to find the exact number. GDP growth is a steady 4%.
In scenario #2 we break even between 2033 and 2034 at which point Disney will have released its final Star Wars movie. Ha ha ha ha. Just kidding. (Fun fact: in scenario #2 we pay off the national debt by 2050.) If that seems too much of a wait then feast your eyes on this next scenario.
Scenario #3
In order to put America on the fast track to balancing its books I've increased the GDP growth rate to 5% per year. Federal spending and revenue are the same as in scenario #2 (+1% per year and 17% of GDP respectively, for those who are keeping score at home).
Good news: we break even by 2022 (and pay off the debt by 2036). Bad news: we haven't had 5 years of 5% growth since the early 1960s when JFK and LBJ were in the White House. One reason for this is inflation.
If the economy is growing because everyone is purchasing more goods and services--as is the hope when making tax cuts--at some point the firms who make the goods and services are going to have a hard time keeping up with demand. It could be a difficulty finding enough raw material to make all the goods that people are buying ("We need more porcelain!"). Or difficulty finding enough skilled people to make the goods and provide the services ("We need more Osmonds!").
As the firms have to work harder and invest more to produce enough goods and services to keep up with increased demand it becomes more costly to do business. The producers of goods and services then raise their prices to reflect that supplying all these goods and services has gotten costlier. And when the prices on most goods and services go up that’s inflation. You might have more money (thank you, tax cuts) but you can't buy extra stuff like you used to because prices have gone up (thank you, inflation).
The federal government of the last half century is not a big fan of inflation because it can to lead to recession. If prices go up too much, people stop buying as much stuff and the economy shrinks. (I would have bought that toilet at $120 but not $150.) So the government works very hard to keep inflation to a reasonable level.
All of this is a long way of saying that there are natural limits to how fast the economy can grow safely. (During the aforementioned debate, Mr. Trump noted that India is experiencing 7% GDP growth. He neglected to mention that they also have 6.75% average inflation over the last five years.)
So what?
Cutting taxes in order to spur the economy to grow at such a rate that the government will make up its losses is a dangerous gamble. Personally, I think it's fiction. And I think portraying a tax cut as a sustainable economic engine is foolish at best and a scam at worst. Five years of growth at 5% is not unreasonable, inflation notwithstanding. But you have to consider my projections on spending and revenue are still far too rosy. (I'm not going to flash another table at you but if we take scenario #3 and just drop revenue to 16%--the thing that I assume tax cuts do--the break even point slips to 2024. And 7 years of 5% growth hasn't happened ever. Although it did average out to that during WWII. Hey, maybe that's why President Trump keeps calling Kim Jong-un "Rocket Man".)
Is President Trump magically going to turn this tax cut into an unprecedented economic engine to help America reclaim its former glory?
I don't think so.
In the meantime the federal government will keep running a deficit and the national debt will continue to grow. Will that debt come due at some point?
You betcha.
What will happen then?
I have no idea. But I'm reasonably sure it's going to be ugly.
Good thing I have a new toilet.