Tax-cut proponents ignore that there’s no free lunch

People listen as U.S. President Donald Trump speaks about tax reform.
Editor's note:

This article originally appeared in Real Clear Markets on November 7, 2017.

Only those who follow politics closely pay much attention when Congress passes a budget resolution—the budget blueprint both chambers agree to that guides the appropriations process. But everyone should take note of the budget resolution agreed to by Congress on October 26, not only because it includes language to expedite Republicans’ tax reform proposals, but also because the resolution itself contains bad news for many Americans. If you have a high income and are wealthy, you stand to win a lot, if you are poor or have modest income, you stand to lose a lot, and if you are old, you should be afraid, very afraid, of what comes next.

To understand what the budget resolution entails, one has to start with the budget baseline, which reflects current policy. Over the next 10 budget years spending will exceed revenues by $10.1 trillion under current policy, according to projections of the Congressional Budget Office. In reality, the gap is likely to be larger. The Federal Highway Administration and the Environmental Protection Agency estimate that more than $1.2 trillion is needed to restore U.S. roads and drinking systems—more if one wants to modernize airports, harbors, and other so-called ‘infrastructure.’ And, of course, there is the opioid crisis.

So, how does Congress propose to deal with these fiscal challenges? For starters, it proposes to cut taxes up to $1.5 trillion. Cutting taxes when revenues are already far short of spending seems transparently wacky. So Congress deals with that apparent fiscal tomfoolery in the simplest way. It assumes away most of the revenue loss. In an economy already at full employment, it assumes that tax legislation will make the economy grow so much faster that—you guessed it!—revenue will go up enough to pay for the rate cuts.

Has growth ever paid for tax cuts? Actually, yes—when the economy was operating well below capacity. In those conditions, tax cuts can bring the economy closer to full employment by adding to demand for goods the economy is able to produce. That adds to revenues. But when the economy, as now, is bumping against maximum capacity, tax cuts have never paid for themselves, or even close to it. And there is no reason to think that the Republican plan, released by House Republicans on November 2, will do so either. In fact, it could do the reverse because it excuses from all U.S. tax the profits of foreign subsidiaries of U.S. corporations, thereby creating an incentive for U.S. corporations to invest abroad rather than in the United States.

To prevent explosive growth in federal budget deficits and debt while cutting taxes, the Republican budget plan proposes a number of steps. First, forget about any spending increases where added spending is needed—no increases for infrastructure and none for the opioid crisis. What it does call for is massive spending cuts, mostly to programs that serve low- and moderate-income households:

  • $473 billion in Medicare spending;
  • $1.3 trillion in Medicaid, Affordable Care Act tax credits and cost sharing subsidies, and other health spending;
  • $653 billion in income security spending, a category that includes such items as SNAP (formerly food stamps), child nutrition, Supplemental Security Income (which provides income to poor old folks and people with disabilities), unemployment insurance, and other programs that serve people with low or moderate incomes;
  • $199 billion in education and social services, a category that includes grants and loans to help children from poor and moderate-income families afford college;
  • and $800 billion of cuts to the mélange of government programs known as ‘non-defense, discretionary’ spending — a new ‘magic asterisk’ that stands for cuts legislators are unwilling to name even in general terms.

So if you are elderly, poor, or otherwise dependent on the social safety net, the short-term news is bad enough. The future is worse.

So if you are elderly, poor, or otherwise dependent on the social safety net, the short-term news is bad enough. The future is worse. The population is aging and medical costs are rising. That means that the United States would have to pay more in taxes in the future than in the past simply to avoid reneging on basic commitments to the elderly, disabled, and poor. How much more? Even if one assumes that the proportion of income spent on government other than Social Security, Medicare, and Medicaid falls, total spending would claim about 2½ percent more of GDP than it has on the average for the past few decades, according to detailed analysis from the Center on Budget and Policy Priorities. To avoid such tax increases, the nation will have to shred the nation’s web of protections for the elderly, poor, and people with disabilities.

This year’s Congressional budget resolution proposes to start doing just that. It proposes to undermine most of that web of protections. The exception is Social Security, on which the budget resolution is silent because law prohibits budget resolutions from changing Social Security. But silence cannot last, as revenues at current rates and accumulated reserves will sustain Social Security benefits only until about 2034.

So, the elderly, people with disabilities, and widows and surviving children who count on Medicare and Medicaid to cover most of their health bills should understand that today’s tax cuts heighten pressure to cut health benefits and much else. And they should recognize as well that tomorrow will require tax increases tomorrow just to sustain current Social Security benefits.