Wednesday, December 14, 2016

Republican Tax Plan likely to cause "an explosive rise in federal debt" according to Centrist former Treasury Secretary Lawrence Summers (Michael Simkovic)

Former Secretary of the Treasury Lawrence Summers recently warned that President Elect Donald Trump's proposed tax reform plan "will massively favor the top 1 per cent of income earners, threaten an explosive rise in federal debt, complicate the tax code and do little if anything to spur growth."

Summers served as Secretary of the Treasury during the Clinton Administration, during one of the few periods in the last 4 decades when the Federal Government ran a surplus budget.  Summers is a Professor of Economics at Harvard University, served as the President of Harvard University, was the Chief Economist of the World Bank, was the Director of the National Economic Council, and was a managing partner at hedge fund D.E. Shaw.  

Summers is widely regarded as data-driven, rigorous, and centrist (Summers has complained about "absurd political correctness" in academe and his potential nomination as Chairman of the Federal Reserve was opposed by Progressive Democrats).  

Summers wrote:

"Unfortunately, neither the Trump plan, nor the one put forward by Paul Ryan, speaker of the House of Representatives, provides for nearly enough base-broadening to finance all the high-end tax cutting they include.


Steven Mnuchin, Treasury secretary-designate, asserts there will be no absolute tax cut for the upper class because deductions would be scaled back. The rub is that totally eliminating all deductions for those with incomes over $1m would not even raise enough revenue to cover reducing their marginal tax rates from 39 to 33 per cent, let alone offset their benefit from huge rate reductions on business and corporate income, and the elimination of estate and gift taxes.


Estimates of the Trump plan suggest that it will raise the average after-tax income of the 0.9 per cent of the population with incomes over $1m by 14 per cent, or more than $215,000. This contrasts with proposed tax cuts for those in the middle of the income distribution of $1,000, or about 2 per cent.


The repeal of estate and gift taxes is especially problematic because it would provide a window for the very rich to use gift and trust structures to ensure that their wealth passes without tax not just to their children but to their grandchildren and great grandchildren, regardless of subsequent legislation. . . .


The envisioned Trump tax cut is about the same size relative to the economy as the 1981 Reagan tax cut. It is worth remembering that Reagan, hardly a fan of reversing course or raising taxes, found it necessary to propose significant tax increases in 1982 and 1984 (the equivalent in today’s economy of $3.5tn over a decade) due to concerns about federal debt.



Today’s budget situation is much more worrisome. The baseline involves much higher levels of debt and deficits. Then the economy was suffering from a deep recession; now it [stronger and less in need of stimulus], I can find no basis in either economic history or logic for Mr Mnuchin’s claim that the proposed reforms would increase the economy’s growth rate from its current 2 per cent rate to . . . 3 to 4 per cent . . . Adult population growth has slowed by nearly a percentage point, the gains generated by more women entering the workforce have been exhausted, and it is far from clear why tax reform will hugely spur productivity growth.


Indeed, because the Trump proposal would redistribute after-tax income towards those most likely to save it, push up long-term interest rates because of debt pressures, increase uncertainty and the advantages of overseas production, it is as likely to retard growth as to accelerate it."


Republicans since Arthur Laffer and President Reagan have hoped that tax reductions and military spending would spur sufficient economic growth to offset the budgetary impact--essentially that the ratio of Debt to GDP would decline because GDP would increase faster than debt.

The theory has never delivered on its promises.  

Debt to GDP rocketed up during World War II, declined during the high growth and high-tax period from 1946 through the 1960s, leveled off during the 1970s, and has generally been growing since the early 1980s as economic growth slowed, legal changes eroded the tax base, and public spending shifted away from pubic investment.  Debt to GDP exploded in the aftermath of the financial crisis, as tax cuts and stimulus spending were deployed in a bid to reduce the severity of the recession that followed.  Debt to GDP declined slightly in 2015 as the economy improved.

The primary exception to the trend toward rising debt-to-GDP ratios since the 1980s was from 1995 to 2001, which happens to coincide with both Lawrence Summers' tenure as Secretary of the Treasury and the late 1990s "tech boom."  


Proponents of Laffers' theories maintain that economic growth and debt to GDP would have been even worse without the Reagan's tax reforms and military buildup.


Note: This post was updated on 12/15 to change the characterization of Lawrence Summers from "Center-right" to "Centrist" after a knowledgable reader argued that Summers is Center-left.

Guest Blogger: Michael Simkovic, Of Academic Interest, Science, Weblogs | Permalink