Tax and Fiscal Policy

US Republicans have given up any pretence of fiscal conservatism

So much for US Republicans starving the government beast.

When the party’s major tax reform package passed in December, Democrats worried that projections for a $1 trillion debt increase over a decade would be used by Republicans to justify spending cuts and reforms to old-age entitlements.

Instead, with a looming government shutdown, Republican and Democrat leaders last week conspired to pass a budget-cap busting spending package. This increased outlays by around $300bn over two years – a rise that no doubt will become the new baseline thereafter.

People decry a lack of bipartisanship in the US, but Congress has shown that when you get a cross-party consensus, taxpayers suffer.

Under these plans, military spending would be raised by $80bn in 2018, and then $85bn in 2019. At Republicans’ request, the US will have added around one-and-a-half times the UK defence budget to its military spending its year.

And now we know what “working across the aisle” really means – chucking money your opponents’ way. Democrats pushed for matching increases in non-defence spending, and eventually settled for an extra $63bn in 2018 and $68bn in 2019. This cross-party spending spree will result in a budget deficit that Jeremy Corbyn would be proud of.

According to the Congressional Budget Office, the US was already projected to run a deficit of 4.7 per cent in 2019 after the tax cuts, up from 2.9 per cent in 2017.

Given reasonable economic assumptions, we are looking at the US federal government now running deficits in excess of 5.6 per cent of GDP, and then increasing further. All this comes, of course, after a long period of sustained growth and with unemployment at a 16-year low of just 4.1 per cent.

This makes no economic sense from any school of thought.

In Keynesian terms, now is the time to fix the roof while the sun is shining. Certainly, the deficit should be restrained to levels necessary to get the debt-to-GDP ratio back on a downward path.

With monetary policy tightening, unemployment low, and most forecasters estimating that the US is already growing above potential, there is no case for any kind of “fiscal stimulus” today.

It is utterly irresponsible from a pure public finance perspective too.

The country’s burgeoning entitlement spending, which is driven by an ageing population, means debt is forecast to increase exponentially from here to the future absent reform to those programmes.

Even before the recent tax and spending changes, the Congressional Budget Office thought debt held by the public would rise from 78.7 per cent to 150 per cent by 2047. Facing these headwinds with higher debt levels risks large future fiscal consolidations being needed. At that stage, no doubt taxes will be hiked, therefore reversing some of the pro-growth effects of the recent tax reform.

Sadly, the Republican establishment has shown that they can no longer claim to be fiscal conservatives. The revenue impacts of the tax reform bill had a big enough effect on the debt. But arguably net tax cuts were necessary to grease the wheels of pro-growth reforms, such as cutting the corporate tax rate, and lowering marginal income tax rates. Otherwise too many losers kick up a fuss.

But in the long run, spending is the true burden of government activity.

The Republicans should have been telling voters that if they want to keep their tax cuts, there needs to be some fiscal restraint.

Instead, they have now given up any pretence of caring about the government debt burden.

We are therefore left with the bizarre spectacle of President Trump having last year advocated for balancing the budget over 10 years, only for a Republican-controlled Congress to present him with proposals that will blow up deficits to more than $1 trillion per year.

Extrapolating this forward, the only feasible means of the US getting on top of its terrifying debt outlook is to reform the generosity and eligibility of entitlements, yet Trump has effectively said this will not happen.

Congress can therefore form all the groups and task forces it wants about how to deal with the long-term debt challenge. But the truth is current politicians have conspired to put the US in a very worrying position indeed.

Not only is the long-term outlook unsustainable with untouchable entitlement growth, but the country is now running up huge debts even in a strong and growing economy.

With a starting point of high debt levels and a political equilibrium where agreement can only be found to raise spending upwards, at the moment, it is difficult to see a way out.


This article was first published by City AM.

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