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Is This The Right Time For a Big Tax Cut?

Dec 4, 2017
Originally published on December 4, 2017 9:50 pm

Republicans say the tax-cutting overhaul being debated in Congress will jump-start the U.S. economy, leading to a lot more investment and hiring by companies.

But some economists say the tax plans — which would sharply cut corporate and business taxes and eliminate numerous deductions for individuals — come at precisely the wrong time. Lower taxes could also be undercut by Federal Reserve policymakers, who are gradually raising interest rates, they say.

Tax cuts can be a good way to stimulate the economy when growth is slowing down, by encouraging businesses and people to keep spending when their finances are growing tighter.

But the economy is in the midst of its longest postwar recovery on record, with an annual growth rate of 3.3 percent last quarter. The unemployment rate is down to 4.1 percent.

Economists often argue that during periods of growth like this, governments should be paring down debt, giving them more fiscal breathing room during the next recession.

"It's always valuable to keep your powder dry, if you can, so you do have fiscal space if there is a downturn," says former Fed governor Randall Kroszner, now a professor of economics at the University of Chicago Booth School of Business.

But the Republican tax cuts would create more than $1 trillion in debt over the next decade, according to Congress' Joint Committee on Taxation.

"I think the timing of this tax cut from the perspective of the deficit is completely upside down," says Jared Bernstein, senior fellow at the Center on Budget and Policy Priorities.

He adds, "When you get to this stage of recovery and you're closing in on full employment, you absolutely want your deficit and debt to be coming down."

There's an even bigger, macroeconomic problem with pushing through tax cuts right now.

If tax cuts are done right, they can increase incentives for investment and lead to productivity growth, Kroszner says.

But they can also lead to higher inflation, which can spur the Fed to raise interest rates. "If it's seen as something that's just short term, the Fed is likely to offset that by making sure the economy doesn't overheat and inflation doesn't get too high," Kroszner says.

That's a real concern right now. To Fed policymakers, the economy is already at or near full employment. They've already raised rates twice this year and are widely expected to do so again this month.

While supporters say that tax cuts would boost growth, Fed officials may decide they amount to more stimulus than the economy needs.

"I think they would say we already have pretty much a fully employed economy. A boost to aggregate demand is not exactly what the doctor ordered at this point. So maybe we should offset some of it by raising interest rates faster," says former Fed Vice Chairman Alan Blinder, a professor of economics and public affairs at Princeton University.

In an interview with The Wall Street Journal last week, New York Fed President William Dudley said he supported efforts to make the tax code simpler, but he appeared to question the need for a tax cut.

"It would be a reasonable question to ask, is this the best time to apply fiscal stimulus, when the economy's already close to full employment?" Dudley said. "It's probably not the best time."

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MARY LOUISE KELLY, HOST:

Republicans are smoothing out the details of their tax overhaul legislation. They're hoping for final passage this month. They say the changes will lead to more jobs, more investment. Most economists, though, are questioning the timing. They say the U.S. economy is already at near-full employment, and pushing for faster growth in 2018 could backfire. NPR's Jim Zarroli reports.

JIM ZARROLI, BYLINE: It sounds like an admirable goal. Grow the economy. Create more jobs. Surely no one could object to that. But in the opinion of some economists, a tax cut is the last thing the U.S. needs right now. For one thing, the economy has been growing steadily for years. Growth last quarter was a healthy 3.3 percent. Unemployment is down to 4.1 percent. Jared Bernstein of the liberal Center for Budget and Policy Priorities (ph) says this isn't the time to be thinking about a tax cut. For one thing, there's the impact it will have on federal borrowing.

JARED BERNSTEIN: I think the timing of this tax cut from the perspective of the deficit is completely upside down.

ZARROLI: Bernstein says he no deficit hawk, but he says when the economy is growing, common sense says you should be paying off some of your debt.

BERNSTEIN: It's that simple, you know? What are you supposed to do with your roof when the sun shines? Fix it, not put a hole in it.

ZARROLI: Instead, according to Congress's Joint Committee on Taxation, the tax overhaul could add a trillion dollars to the debt over the next decade even after taking extra growth into consideration. That means the government won't have as much money as it needs when the next recession comes around. On ABC "This Week" yesterday, Senate Majority Leader Mitch McConnell dismissed deficit concerns.

(SOUNDBITE OF TV SHOW, "THIS WEEK")

MITCH MCCONNELL: So I'm confident this is not only revenue-neutral to the government but actually is very likely to be a revenue producer.

ZARROLI: McConnell says the tax cuts will lead to faster growth, which will mean more revenue for the government, and that should keep the deficit in check. But there's another macroeconomic problem with cutting taxes right now. Former Fed Governor Randy Kroszner says if a tax cut is designed well, it can be a good thing. It can mean companies have more money to spend on new factories and equipment.

RANDY KROSZNER: To the extent that the tax reform focuses on trying to increase the incentives for investment, increase productivity growth in the economy, that's always a plus.

ZARROLI: Kroszner says the tax bill being considered by Congress appears to have some good features in it, but he says there's always a risk cutting taxes will lead to higher inflation. And if it looks like that's happening, the Federal Reserve will step in to cool down the economy.

KROSZNER: If it's seen as something that's just short-term, the Fed is likely to offset that to make sure the economy doesn't overheat, and that is, inflation doesn't get too high.

ZARROLI: The Fed has raised rates twice this year and is expected to do so again this month. Former Fed Vice President Alan Blinder says there's already a consensus on the Fed that the economy is at or near full employment. Increasing demand by cutting taxes could amount to more stimulus than the economy needs.

ALAN BLINDER: I think they would say, we already have pretty much a fully employed economy. A boost to aggregate demand is not exactly what the doctor ordered.

ZARROLI: So this is a strange situation. When the Great Recession began a decade ago, both Congress and the Fed tried to do whatever they could to bolster the economy, but now they're beginning to pull in opposite directions. Last weekend, the head of the New York Federal Reserve, William Dudley, seemed to question the need for a tax cut. He told the Wall Street Journal it's probably not the best time to be trying to stimulate the economy. So while Republicans say they want to make the economy grow faster, Fed policymakers could actually undercut that effort by raising interest rates. Jim Zarroli, NPR News, New York.

(SOUNDBITE OF TAKENOBU'S "MOMOTARO") Transcript provided by NPR, Copyright NPR.