MICHAEL KEATING. The Trump Tax Cuts and Economic Growth

The forecast positive impact of the Trump tax package mainly results from a temporary incentive to bring forward business investment. This is irrelevant to the cuts in company tax rates proposed by the Turnbull Government, and cannot be used as vindication for their policies. Furthermore, the Trump tax package fails to address the fundamental flaws in the US economy, and in the longer term, has a negative impact on US economic growth.  

On the 22nd of January 2018 the IMF released the latest update of its world economic outlook. The headlines that followed in the Australian press were:

  • US tax cuts fuel world growth (Fairfax Media), and
  • Trump tax cuts lifting world economy (The Australian).

Not surprisingly our Treasurer and Prime Minister quickly followed up claiming vindication for their own proposed company tax cut and the benefits it would bring to our economy, if not quite the world economy.

But what did the IMF really say, and how much difference will a cut in the company tax rate really make to the rate of economic growth over the next few years, rather than just the next year?

First, it is correct that the IMF has revised upwards its forecasts for US economic growth. However, because of the normal lags before policy changes take effect, most of the improved economic growth so far since Trump became President, must be attributed to the carryover from Obama’s policies, not any Trump effect. In addition, the stronger than expected US economic activity in 2017 is the reason for part of the upward revision of the outlook for 2018 and 2019. Nevertheless, the IMF does expect Trump’s tax reform package to stimulate near-term economic activity in the US, adding 1.2 per cent to US GDP by 2020 (assuming that there are no off-setting spending cuts over this period).

Second, the IMF does not attribute the main impact of the Trump tax reform package to the cut in the company tax rate from 30% to 20%. Instead, the IMF considers the main impact on economic growth is ‘largely because’ of the new temporary allowance that allows US companies to fully expense their investment over the next few years. Because that allowance is temporary, it creates an incentive to pull forward new investment, and this is the principal reason for the forecast increase in US economic growth in the next couple of years. However, that allowance mainly achieves its impact precisely because it is temporary, and so when it ceases, business investment will then contract.

Third, and most importantly, this temporary investment allowance has nothing to do with the proposed cut in US company tax rates. Accordingly, even the short-term success of the Trump tax package, cannot be used as vindication of our Government’s proposed cut in company tax rates.

Fourth, the IMF also forecasts that US economic growth will be lower than in previous forecasts from 2022 onwards, and so the initial positive impact of the Trump is considered unlikely to be sustained. This downward revision in the longer-term outlook for the US economy is partly a result of the temporary nature of the main investment stimulus, as already explained. However, the lower growth outlook for the US is also because, as the IMF notes, the increased budget deficit will show up in an increasing trade deficit, higher interest rates and a stronger exchange rate: all of which will act to reduce future economic growth. In sum, the IMF Chief Economist, considers that ‘for the US, whatever output impact its tax cut will have … will be paid back later in the form of lower growth’.

In addition, to these negative features of the Trump tax package on economic growth, which the IMF has recognised, I would like to add a couple more points of my own.

In my view the fundamentals of the US economy continue to be very unsound, with little or no progress being made in unwinding the factors that created the Global Financial Crisis (GFC). There is far too much debt, asset prices are over-valued relative to expected returns, and aggregate demand will continue to stagnate as long as inequality continues to increase. And Trump’s policies do not address these basic economic flaws; rather Trump’s policies only make them worse.

Instead, the money spent on tax cuts for the rich, would have been much better spent on improving the capacity of the American workforce to adapt and benefit from technological change, which is the fundamental cause of the problems being experienced by so many of Trump’s supporters. In addition, in the IMF’s opinion, priority areas for reform include ‘avoiding competitive races to the bottom in taxes’.

Michael Keating is a former Secretary of the Departments of Employment & Industrial Relations, Finance, and Prime Minister and Cabinet.

print

Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations.  He is presently a visiting fellow at the Australian National University. 

This entry was posted in Economy, Politics. Bookmark the permalink.

Please keep your comments short and sharp and avoid entering links. For questions regarding our comment system please click here.
(Please note that we are unable to post comments on your behalf.)