Trump is hooked on deficits

Politically, the answer may not matter all that much. As long as the economy continues to advance, Trump will probably receive the lion’s share of credit. For better or worse, incumbents usually get rewarded or blamed for the state of the economy when they’re in office. Still, the administration, through the White House’s Council of Economic Advisers (CEA), has mounted an aggressive campaign to show that good policies — not good luck — are the main reason the economy is faring so well.

The gist of the CEA’s case is to compare the economy’s actual performance with what was predicted before Trump’s election. If the actual performance substantially exceeds the predicted performance, then something must account for the difference. The “something,” the CEA says, is better policies. Since the 2016 election, the economy has added more than 7 million jobs, far more than the 1.9 million jobs forecast by the Congressional Budget Office. Similarly, says the CEA, growth of the economy’s output (gross domestic product) has exceeded earlier forecasts.

The result, it has argued, has been a huge drop in unemployment across virtually all major ethnic, educational and racial groups, as the table below shows. For example, among African Americans, the peak monthly unemployment rate fell from 16.8 percent in March 2010 to 6 percent in January of this year. Other groups also enjoyed large declines.

The administration argues that the poor and the near-poor were among the biggest beneficiaries. “The labor market experiences that people are gaining today will change the trajectories of their lives—and those of their children—for years to come,” wrote Trump in the “Economic Report of the President,” a shorter version of the CEA report.

All this seems impressive. So what’s all the fuss about? Just this: There’s an alternative explanation of what happened. In this telling, the sustained economic expansion doesn’t result mainly from Trump’s lower tax rates, deregulation and trade agreements. Indeed, it’s widely acknowledged that Trump’s trade wars with China depressed economic growth because they created greater uncertainty.

Trump’s theory is that by lowering tax rates the government can stimulate investment and raise living standards. The reason: Investments become more profitable. In 2017, Congress dutifully passed legislation that cut the top corporate tax rate from 35 percent to 21 percent.

But it didn’t work out as planned. There was a spurt of investment after the rate cut, but it rapidly declined. For the first nine quarters after passage of the tax bill, growth of private nonresidential business investment grew at an average rate of 3.4 percent, with faster growth (6.8 percent) in the first four quarters and much slower in the next five quarters (0.8 percent), according to the CEA report.

The implication is that lower tax rates may be much less powerful in stimulating investment than has been assumed. The economy may be more influenced by outside events (Boeing’s 737 Max jet crisis or the coronavirus) that affect the confidence of corporate executives and their willingness — or unwillingness — to invest.

Trump’s policy has been straightforward: keep pressure on the Federal Reserve for low interest rates; and expand budget deficits. The extra spending endorsed by the White House and Congress, along with the 2017 tax cut, has added $4.7 trillion to deficits over a decade, estimates the Committee for a Responsible Federal Budget. The extra spending and tax cuts put more money in the pockets of businesses and consumers, including through higher dividends and stock repurchases. Some of this extra money was spent boosting the economy.

It’s important to acknowledge what we know, what we don’t know and what’s up for grabs. Based on a reasonable reading of the record, the economy’s growth reflects continued reliance on large deficits. How long this can last is one of the unknowns up for grabs.

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