Trump’s promised tax cuts could prove less than ‘tremendous’ for its national debt

“People are going to be very, very happy. They’re going to get tremendous, tremendous tax cuts and tax relief and that is what this country needs,” said US President Donald Trump on Saturday.

But the tax plan may actually not be what the United States really needs. In time, it could actually make matters worse.

Of course in coming months, the novelty of Washington actually managing to pass a package of tax cuts and reforms could well prompt markets to bid up US assets, including the US dollar. Fear of Missing Out could prove a powerful psychological driver for market participants.

But the lurking reality is that over the next decade it is estimated the proposed tax plan will add another US$1 trillion to the US’ national debt.

That is not a figure being bandied about by Trump’s political opponents, but rather the view of the US Congress’ non-partisan Joint Commission on Taxation (JCT).

The JCT estimated on November 30, the positive impact of the tax changes on US gross domestic product (GDP) over the next decade could result in a higher tax take over the period of US$407 billion which would reduce the previously estimated US$1.414 trillion costs of the legislative package to just over US$1 trillion.

That is an extra US$1 trillion that Uncle Sam will then have to borrow in the market.

Many would argue that such an increase in US government debt is neither here nor there, so long as the market is prepared to fund it. But some already have qualms about the situation, even without the burden of another US$1 trillion.

The path of the federal debt “should keep people awake at night”, said Federal Reserve Chair Janet Yellen on November 29.

“US government debt now stands at roughly 75 per cent of GDP, and the present value of unfunded entitlements stands at around $49 trillion,” wrote Dallas Federal Reserve Chief Robert Kaplan on November 27.

Moreover, in Kaplan’s view “the projected path of US government debt to GDP is unlikely to be sustainable – and has been made to appear more manageable due to today’s historically low interest rates.”

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, also has concerns about the upward trajectory of US government debt that will have to be funded by increased borrowing.

“America’s chronic saving shortfall has now moved into the danger zone, making it much more difficult to fund multiyear deficits today than was the case when cutting taxes in the past,” Roach wrote for Project Syndicate on November 24.

Roach makes the valid point that while the US net savings ratio at the time of major tax reforms in 1964 and 1981 “averaged 10.1 per cent during those two years,” “that is not the case today, with the net domestic saving rate a mere 1.8 per cent of national income,” arguing that “saving-short economies simply cannot go on deficit-spending binges without borrowing surplus saving from abroad.”

And that comes at a cost, even if you are Uncle Sam. And it might only grow further if the US consumer chooses to spend his tax cuts on imported goods, thereby increasing the size of the US trade deficit. Rising US twin deficits might not frighten lenders off but likely lead them to demand a higher price to subsidise them.

In truth, the fact that Congress’ tax proposals end up adding to US national debt over the next decade are really just a symptom of an underlying weakness with the package.

Seemingly, it’s just not going to kick-start the kind of upsurge in US economic growth over the next decade that would generate sufficiently higher tax revenues so that the US government can avoid higher borrowing.

The fact that Uncle Sam, meanwhile, will need to borrow even more money could well mean lenders have fewer funds to lend to the US private sector. That may adversely affect the potential for innovation and productivity gains.

“We are suffering from slow productivity growth. In making fiscal policy and other decisions the focus should be on how that can be improved,” Yellen said last week. Some might feel her entreaty has fallen on deaf Congressional ears.

Nevertheless, with 2020 in mind President Trump clearly hopes that the emerging Tax Cuts and Jobs Act will enhance both his own and the Republican Party’s electoral prospects.

Unfortunately it may also be that the legislation proves unfit for purpose and, down the line, leaves the US economy worse off than before.