Between the supply-side economics that inspired President Donald Trump’s tax cuts and the soak-the-rich mantra of the new wave of left-leaning Democrats rising in Congress, the debate over U.S. tax policy is now officially a no-go zone for anyone who thinks deficits matter.
The Republican-controlled Congress that adopted across-the-board tax cuts in 2017 put the country’s public finances on an even more unsustainable track than they had been on, with the Congressional Budget Office projecting revenue shortfalls that will see the federal deficit surpass US$1-trillion ($1.33-trillion) in 2020. Indeed, the deficit rose by more than US$100-billion to US$779-billion in the fiscal year that ended in September, as personal and corporate tax cuts that took effect at the beginning of 2018 ate into government revenue.
Of course, apologists for the Trump tax cuts insist they are responsible for the heady rate of growth the U.S. economy experienced in 2018. But their contention that the tax cuts would pay for themselves – with higher economic growth rates leading to higher government tax revenues – has not played out so far. And according to the CBO’s projections, the Tax Cuts and Jobs Act will blow a US$1.9-trillion hole in the budget that will help send the federal debt held by the public to 96 per cent of gross domestic product by 2028 from 78 per cent at the end of fiscal 2018.
U.S. government debt held by the public – with China being the biggest holder – accounts for about 70 per cent of the total federal debt of US$22-trillion. The rest is made up of so-called intragovernmental debt and consists of money the Treasury Department has borrowed from the Social Security program. But with Social Security benefits (mainly retirement pensions) and Medicare expenditures set to vastly surpass premiums in coming years, the government’s ability to shift its debts around internally will end, forcing it to turn to bond markets to fund an ever-increasing deficit.
Mr. Trump campaigned in 2016 on a promise, albeit an off-the-cuff one, to eliminate the federal debt over two terms in office. Instead, the federal debt has already risen by more than US$2-trillion since he took office. And if a recession hits on his watch, it will explode by trillions above the CBO’s baseline projections.
In other words, a U.S. debt crisis is not some far-fetched scenario, but rather a distinct possibility if Congress fails to start taking deficits seriously.
That’s not about to happen any time soon. Mr. Trump has been been musing about further tax cuts as the sugar high of the current round of cuts starts to wear off. And the new cohort of Democrats who now control the House of Representatives have their own list of spending demands that they will use as ransom in budget negotiations.
Indeed, newly elected progressive Democrats such as Alexandria Ocasio-Cortez are pushing a Green New Deal, which is essentially a massive stimulus program dressed up as a climate change plan that would ensure every American seeking a job in the green economy gets one. While some aspects of the plan are defensible – including proposals to retrofit or rebuild public infrastructure – massive subsidies for renewable energy and electric cars are not.
To help pay for the Green New Deal, Ms. Ocasio-Cortez advocates increasing the tax rate on personal income above US$10-million to 70 per cent, or almost double the top 37-per-cent rate (down from 39.6 per cent under former president Barack Obama) that took effect in 2018. But it is unlikely that a 70-per-cent tax rate would bring in much revenue at all, as the wealthiest Americans employ a host of strategies to reduce the government’s take.
Supporters of Ms. Ocasio-Cortez’s idea point out that the top U.S. marginal tax rate stood at or exceeded 70 per cent for the entire postwar era until 1981, a period that is largely seen as a golden age of economic growth. What they fail to point out is that a smorgasbord of deductions meant almost no American paid anywhere near the top rate back then. And the tax reform bill adopted under Ronald Reagan in 1981, which cut the top rate to 28 per cent, eliminated many of those deductions. As a result, the gap between the stated and effective top rate narrowed considerably.
As France and Britain both discovered in recent years, raising the top personal income tax rate above 50 per cent usually leads to a reduction in government tax revenues as the wealthiest citizens take up residence elsewhere or convert earned income into investment income, which is taxed at a lower rate. Both countries were forced to cut their top rates as a result.
That’s not to say the supply-siders whispering in Mr. Trump’s ear have been vindicated, either.
“There is certainly some level of taxation at which cutting tax rates would be win-win,” Harvard University economics professor Gregory Mankiw, who chaired George W. Bush’s Council of Economic Advisers, wrote in a recent Foreign Affairs review of the book Trumponomics. “But few economists believe that tax rates in the United States have reached such heights in recent years; to the contrary, they are likely below the revenue-maximizing level.”
Neither low-tax Republicans nor high-tax Democrats can agree on what that level might be. All they seem to agree on is that the deficit is not their problem.