Markets continue to cheer the tax reform bill, but its effect on the economy is far from certain.
Speaking in broad strokes, there are two general ways of analyzing President Donald Trump’s tax reform bill. The first is to go deep into the nitty-gritty of it. Try to determine who exactly is going to be taxed less, who is going being taxed more and whether the redistribution of the tax burden is going to help or hurt the economy due to the spending/saving/capital investment habits of each specific group. Then make your argument.
The second way is to just take a general overall snapshot and see from there if we are going in the direction of burdening or freeing the economy.
The bottom line of any tax reform is really the net change in government spending plus taxes actually collected. If the combination of government spending and tax revenue goes up, then the economy is being constricted more. If the combination of spending and tax revenue goes down, then the economy is being constricted less.
In order to understand why this is so, it helps to picture the extreme case. If, for argument’s sake, the combination of government spending and taxes collected totaled 100% of GDP, that would mean that no private economy remained in the country. No participant in it would be able to choose where to place resources by profit motive. In other words, it would not be an economy at all, as an economy is literally the interplay of scarcity and choice.
That said, the consensus about Trump’s tax reform bill is that it would add $1.5 trillion to the national debt, without lowering the cumulative tax burden at all. In fact, the “revenue neutral” mantra has been hammered for months, with Republicans insisting that revenue coming into the Treasury would not be affected on net. If tax reform is revenue neutral and at the same time adds to the deficit which in turn is only paid for in taxes, it is therefore a net tax raise, not a tax cut.
A revenue neutral tax cut is like a private company telling its shareholders that it is taking control of its balance sheet through revenue neutral spending cuts. On the one hand the company insists to its shareholders that it wants to become more fiscally responsible, without actually becoming any more fiscally responsible. The farce can only go on so long before shareholders figure it out and dump the stock.
The stock in this case, though, is the U.S. dollar itself. A $1.5 trillion addition in debt and no spending cuts, coupled with a protectionist, tariff-heavy outlook on trade, means that the economy will be even more burdened than it was beforehand. When those who buy U.S. Treasuries figure this out, they will sell, and interest rates will rise across the board along with the service costs on the national debt. Taxpayers will eventually be stuck with the bill, meaning higher debt means eventually higher taxes, in some form or other, whether it be inflation of straight-up tax raises or entirely new taxes like a value-added tax.
The long-term effect of the bill then is a tax raise, and it will not free the economy or improve it in the long term.
