President Donald Trump's tax plan needs economic growth of 3 percent or more to help generate enough tax revenue to avoid trillion-dollar deficits and more debt.
The first estimate of third-quarter GDP shows that the 3 percent target has been reached for two quarters in a row, even though the Republican-controlled Congress has yet to approve tax or healthcare reforms. It’s the promise of those reforms that may be helping to drive momentum.
Larry Kudlow, the Reagan administration economist who also advised the Trump campaign, earlier this week said he was worried that the House of Representatives isn’t estimating how fast the U.S. economy will grow if taxes are cut. The lower growth forecast may mean lawmakers won’t approve some cuts, such as for corporate tax rate.
“I’m hearing, for example, they may not use a 3 percent growth baseline, which is worth several trillion dollars,” Kudlow said on financial news channel CNBC. “That they will use a Joint Tax Committee baseline which means no dynamic scoring – will cost them a fortune. The only way they can get this done is a 3 percent growth path, the mother of pay-for’s.” Dynamic scoring is a tool to give members of Congress the information they need to evaluate the tradeoffs in tax policy changes.
The Congressional Budget Office and the Joint Committee of Taxation score legislation to measure its effect on tax revenue. In the current debate about tax reform, many of the complaints about the CBO focus on its estimate for an economic growth rate of less than 2 percent, while proponents of major tax cuts insist their proposals will produce growth of 3 percent to 4 percent.
The third quarter growth number of 3 percent, beating the consensus estimate of 2.5 percent, follows 3.1 percent growth in the second quarter, making for the best back-to-back quarters since 2014 and ending a long streak of sluggish 2 percent growth. Hurricanes Harvey and Irma in September didn’t hurt the U.S. economy as much as some economists had predicted.
"Give credit where credit is due," Chris Rupkey, chief financial economist at MUFG Union Bank, wrote in a report cited by CNBC. "Trump's economics team has been steering the country since January, and the economy has hit the Administration's 3 percent target two quarters in a row…This economy in its ninth year of expansion shows no sign of tiring and turning down and may outlast the 10 years of growth during the Clinton presidency."
Congressional Republicans are expected to introduce a bill on Wednesday that would cut corporate and individual taxes, CNBC reported.
The White House on Friday took credit for the better growth and urged Congress to act on tax cuts and other Trump agenda items. The White House also released a new report that said tax cuts could deliver 3 percent to 5 percent GDP growth.
"With unemployment at a 16-year low, the stock market at new highs and economic confidence soaring, the U.S. economy is surging under this President's leadership. America can continue this momentum if Congress adopts our framework for major tax cuts and other key agenda items that will allow Americans to keep more of their money, make our businesses more competitive, and build an economy that works better for everyone," said White House Press Secretary Sarah Sanders.
A jump in business spending during the third quarter was an important part of GDP expansion.
"Partly it's a reflection of increased optimism about the economy, and we've seen big increases in manufacturing PMIs, and confidence measures and that could be feeding through to animal spirits. Business investment is difficult to forecast partly because it comes down to expectations," Scott Anderson, chief economist at Bank of the West, told CNBC.
While the White House takes credit for the stronger economy and record-high stock prices, the Federal Reserve earlier this month suggested President Donald Trump should thank the U.S. central bank.
Tax cuts didn’t help stocks in the three-decade era ushered in by then-Fed Chairman Paul Volcker, who took office in 1979, according to a report by Fed economist Anthony Diercks and William Waller of Carnegie Mellon University.
Tax cuts raised anticipation that Fed officials would offset them with interest-rate increases, the authors said. They said stocks may have rallied because U.S. central bankers have adopted greater caution toward tightening in the wake of the 2008 financial crisis and subsequent slow economic recovery.
From 1980 to 2008, increases in discount rates associated with news about tax cuts swamped the positive effects of cash flow that tax cuts would have on stock prices, they said. Higher interest rates would have slowed economic activity, cutting the cash flow generated by tax cuts.
"The recent experience could be due to a few issues: (1) there are additional factors at play such as changes in regulation, government spending, and repatriation that may be important, (2) because of the proximity to the zero lower bound monetary policy may not be acting as aggressively as it did in previous post-1980 tightening cycles, and (3) investors are unusually optimistic," Diercks and Waller wrote.
The White House next week will name its nominee to be the next chair of the Fed. Fed Governor Jerome Powell and John Taylor, an economics professor at Stanford University, are said to be the final two candidates for the job.
A key question is whether tax cuts will spur economic growth so much that the government will end up collecting higher revenues, as supply-side economists like Art Laffer have argued, or only add to the federal debt of about $20 trillion. Presidents George W. Bush and Barack Obama both oversaw about a doubling in taxpayer debt for wars and social programs in each of their eight-year terms.
Ideally, tax reform will give middle-class earners incentives to work and earn more, and for businesses to invest and hire — in true supply-side form. Critics say the cuts will only help the rich get richer while the U.S. taxpayer goes deeper into debt.
David Stockman, who was the director of the Office of Management and Budget under President Ronald Reagan, last week said Treasury Secretary Mnuchin's claim that the tax cut will pay for itself is unrealistic.
“Really, I think the guy is clueless. I think the notion that we are going to have a big, big tax cut is a pipe dream. They can’t pay for it,” Stockman told Fox Business Network.
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