By Masashi Amano / Yomiuri Shimbun Economic News EditorWill the tax cuts being promoted by U.S. President Donald Trump’s administration support U.S. economic growth? Success in this area hinges on what happens regarding concerns about the deficit, the cuts’ practicality, and differing proposals by the U.S. House and Senate. The possibility that the tax cuts could actually hinder growth must be considered.
At the core of the tax cut plan is a reduction in the corporate tax rate from 35 percent to 20 percent. It also expands the child tax credit. The plan aims to stimulate investment and consumption (see chart 1), with Trump promising, “It will be the biggest cut in the history of our country. Companies and jobs are coming back to our great American home.”
U.S. stock prices have remained high due to expectations over tax cuts. Yet not everyone has high hopes for the plan.
Will the public see a “faded rose” again? A senior official in the U.S. government recently lamented as such to a longtime acquaintance in Japan who formerly served in the bureaucracy.
The administration of U.S. President Ronald Reagan in the 1980s advanced the Reaganomics economic program centered on tax cuts, promising a “rosy scenario” in which growth would accelerate and the budget would return to a surplus.
Reaganomics led to a drop in the unemployment rate and price stabilization, among other outcomes, but also gave way to “twin” budget and trade deficits.
Massive government bond issuances were required to fill the gap created by the deficit, with substantial capital absorbed by the government bond market.
Loan interest rates for businesses soared due to the lack of capital, investment slowed, and economic activity stalled.
Reaganomics eventually imploded, leaving the public nothing more than a “faded rose.”
Anxiety within the government is rising once more as the country again faces the prospect of an exploding deficit.
The tax cut is expected to total $6 trillion, or ¥680 trillion, over 10 years. Parallel measures to boost tax revenue, including rolling back various deductions, will raise more than $4 trillion. Overall, revenue is expected to decrease by about $1.4 trillion.
The U.S. budget deficit currently stands at about $670 billion, or 3.5 percent of gross domestic product.
The U.S. Congress predicts the tax cuts and rising social security expenses due to the aging population will push up the deficit to about $1.7 trillion 10 years later. The resulting budget deficit and outstanding government obligations will reach 6 percent and 97 percent of GDP, respectively (see chart 2).
By comparison, Japan’s own perilous budget and outstanding obligations are 4.5 percent and 155 percent of GDP, respectively.
Though the United States’ outstanding obligations 10 years from now will still be lower than Japan’s current figures, there is no reason for optimism.
The U.S. budget deficit is said to enter a “danger zone” when it exceeds 5 percent of GDP, portending a surge in interest rates, as happened during the Reagan era. Concerns run deep, even if the decrease in revenue stays within $1.4 trillion.
There is also the possibility that the decrease in revenue will be greater than projected.
There are likewise worries that Congress, conscious of next autumn’s midterm elections, will seek to appease voters and industry groups by reducing the scale of unpopular revenue-increasing measures from $4 trillion.
The current administration’s seeming indifference toward public finances is deeply troubling.
U.S. Treasury Secretary Steven Mnuchin promised that “the tax plan would accelerate the rate of economic growth to above 3 percent,” while also suggesting that growth spurred by the tax cuts would generate new revenue. He also promised the country would have a budget surplus in 10 years’ time. However, many market players predict that the effect of tax cuts on growth would be 0.1-0.5 percent per year. On the other hand, the potential growth rate, which indicates the real strength of the U.S. economy, is below 2 percent.
The boost provided by tax reductions may be insufficient to realize Mnuchin’s economic growth target of 3 percent.
The economy has already been growing for nine years. Maintaining a pace of 3 percent growth for the next 10 years is a daunting task.
Restoring a budget surplus through tax cuts is a key component of the “Laffer Curve” theory (see chart 3), which underpinned the Reagan administration’s support for massive tax cuts.
However, the budget deficit tripled during this period. Even U.S. President George H.W. Bush, who served as Regan’s vice president, ridiculed such ideas as “voodoo economics” before assuming the presidency. They essentially relied on magic charms to bring about a miracle. The current administration can be similarly criticized for its outlandish forecasts.
Is fiscal expansion necessary?
The initial question is whether tax cuts are the “prescription” needed to strengthen U.S. growth potential. Such skepticism is a source of concern over the tax cuts.
Certainly, the U.S. corporate tax rate is high compared to other major countries.
However, many companies take full advantage of tax incentives and pay an effective rate of 20-25 percent (see chart 4).
Observers question the efficacy of the tax cuts, as the effective tax rate is already lower than the current corporate rate of 35 percent.
The famous investor Warren Buffett said of U.S. companies, “I don’t think any of them are noncompetitive in the world because of the corporate tax rate.”
Some observers believe that fiscal stimulus measures such as tax cuts excessively stimulate the economy during boom periods, leading to labor shortages and high commodity prices.
Under these circumstances, the risk of economic stagnation could rise if the U.S. Federal Reserve Board hastily adopts a rate hike to cool down the economy.
Fed Chair Janet Yellen has also played down the need for stimulus measures such as tax cuts.
Some have said health care reform, infrastructure repairs and education reforms suited for an information technology society merit priority over tax cuts.
There are also concerns about the vastly different tax cut plans proposed by the U.S. Senate and House of Representatives.
The Senate plan, approved narrowly on Saturday, postpones the corporate tax rate cut to 2019 to alleviate the fiscal burden in the plan’s first year, yet the House plan calls for cuts to take effect in 2018.
The Senate plan also aims to stimulate investment by lowering the wealthy’s income tax burden, while the House keeps the current rate for the highest tax bracket in place.
Moreover, the Senate is considering an end to subsidies for health insurance as a means of freeing up resources for a tax cut. There has been opposition to this not only from the opposition Democratic Party but also from within the ruling Republicans.
The gap in the opinions between the chambers is substantial, and the administration’s goal of passing the bill within the year is perhaps too ambitious.
Recently, there have been noticeable drops in both Japanese and U.S. stock prices due to concerns about the direction of tax cut deliberations.
If the debate on tax cuts completely deadlocks, both the Japanese and U.S. markets could wildly fluctuate.
The Plaza Accord (see below), which corrected the strengthening of the dollar due to factors such as the Reagan administration’s tax cuts, is considered to have been an underlying cause for the yen’s sharp appreciation and the long-term sluggishness suffered by the Japanese economy. Tax cuts in the United States also greatly affect Japan.
I wonder if the ongoing tax cut saga will end with a “crimson rose” or a “faded rose.”
Japan must calmly monitor the direction of U.S. tax reform.
■ Plaza Accord
The name commonly attributed to a September 1985 agreement made at the Plaza Hotel in New York by the finance ministers and central bank governors of Japan, the United States, and three European countries. It aimed to depreciate the U.S. dollar, which had strengthened due to factors including a tax cut-fueled rise in the U.S. interest rate. Following the agreement, the yen continued to rise, leading to a bubble economy in Japan powered by monetary easing and its subsequent collapse.Speech