President Trump’s budget plan for fiscal year 2018 has provided the media with new grist for emotionally charged criticism, but is that criticism really fair?
America has a looming budget crisis and potentially an economic crisis to go along with it. The Trump administration has proposed decisive action, albeit with large reductions in both spending and taxes. (The recently released Trump budget proposal contains only the spending elements of his fiscal plan.)
The Trump proposals are considered radical. They cut domestic discretionary spending as a share of GDP roughly in half by 2027. Even defense, after nudging up to 3.2 percent of GDP in 2018 and 2019, declines to 2.3 percent by 2027. The pressure on U.S. defense spending from domestic priorities may be behind Trump’s criticism of NATO defense funding at the recent Brussels summit.
Trump’s budget proposals look a lot less radical, however, when compared with the baseline budget projections that show the path that actual federal outlays are currently on. Trump spending proposals, as shown in the Office of Management and Budget (OMB) Budget Outlays, bring federal outlays back within long-term historical ranges. The alternative, which is to do nothing (i.e., so-called current law spending), would take federal outlays from 20.7 percent of GDP in 2017 to 23.4 percent in 2027 (Chart 1).
In other words, under current law assuming only those increases required to meet legal government requirements, spending as a share of GDP would rise to levels comparable with the peak reached during the financial crisis. Taking a longer historical perspective, the “do-nothing scenario” would increase the federal role by almost one-third relative to the 17.6 percent of GDP share in 2000.
In the spirit of calibrating radical, an increase in federal spending of this magnitude would take the federal role in the economy to levels not seen on a sustained basis in the last 50 years.
Trump’s budget puts a firm stake in the ground, stating that curtailing government spending (we will address taxes in a moment) is healthy for the U.S. fiscal situation and for the economy. While spending under the Trump budget would tend toward the lower end of spending in recent decades, it is not unprecedented.
More important to emphasize is that the do-nothing scenario includes no new spending priorities or imaginative programs to address social needs. Its implicit message is that what we are doing today is just fine and doesn’t require reform or modification.
Even Trump can’t squeeze a meaningful infrastructure program into his own budget despite considerable pruning because of the burden of past commitments. As our adviser, Gene Steuerle, said in our interview Debts of the Past Limit the Future, based on his book Dead Men Ruling, in 2014:
Today’s government is constructed and constricted by programs and policies that were designed by men (women, too, but they were largely excluded) decades ago, many of whom are not with us today. Many of these programs were well designed to improve the economic and social welfare of Americans at the time they were created and some years into the future. But the world has moved on, and these programs have not.
Gene’s message was not fatalistic — far from it:
I want to convince voters and their representatives that we live in an age of extraordinary possibility. This is not an age of austerity, yet we tie a straightjacket around ourselves that stops us from reviewing, revising and reinventing policies crafted by now dead or retired legislators decades ago.
In order to get to the point where we as a nation can introduce new thinking and experimentation in addressing pressing social issues like poverty and lack of opportunity, we have to establish a balance in the fiscal situation. We have to create the fiscal space to provide opportunity for the future.
Trump’s budget does not contain a tax plan. For the first time in living memory, the nation is approaching a fiscal debate without the president’s tax proposals. With that said, we can engage in a few thought experiments to suggest what the tax options might be and how they would affect the future role of government.
The only substantive tax reform plan presented to date is the House Republican Tax Reform Plan that was released in June 2016. This plan contains deep cuts in personal and corporate tax rates, elimination and/or curtailment of tax preferences as well as the much discussed border adjustment tax (BAT).
The static estimate of revenue losses from the plan (that is, revenue losses without taking into account macroeconomic effects) ramp up from about $200 billion in the second year of enactment to nearly $400 billion four years out and then shrink somewhat after that. These revenue losses run in the range of 1 to 1.7 percent of GDP. If the BAT is excluded, the revenue losses increase about 0.5 percent of GDP. If effects on the economy are taken into account, these losses either shrink somewhat (according to estimates from the Tax Policy Center) or are almost eliminated (according to estimates from the Tax Foundation) by 2027.
Even with the least generous assumptions about the economic effects of tax reform, the resulting revenue levels would dip modestly below and then begin to approach the long-term average. The most generous (i.e., from the Tax Foundation) would leave revenues above the long-run average in 2027. In the latter case, the Trump budget would be close to balanced.
Tax reform is not the only alternative. What would the path of taxes look like if they were to increase by the same share of the economy as spending in the current law, or what we call the do-nothing scenario? We will not go into just how difficult it would be to craft such a proposal.
The result would be to raise the tax share of the economy from 17.8 percent, where it is projected to be in 2017, to 20.5 percent in 2027 (note arrow, Chart 2). Taxes would be at a post-World War II historical high as a share of GDP, and the deficit would remain about where it has been (in the range of 2.5 percent to 3 percent of GDP).
(Note: “Feedback” in the chart above refers to macro feedback from Tax Policy Center (TPC) Keynesian model. See An Analysis of the House GOP Tax Plan.)
From my perspective as someone who addressed and, in some cases challenged, the Reagan administration’s economic optimism, Trump’s budget in this respect is remarkably restrained. Real economic growth rates are assumed to stay around 2.5 percent until 2020, when they gradually edge up to 3 percent through 2027. The Trump (OMB) nominal GDP assumptions are almost identical to CBO’s until 2020 and differ by less than 15 percent in 2027 (Chart 3).
The point of this exercise is to show that the Trump budget is not an alt-right policy attack on the federal government but rather presents a real choice regarding the future role of government. Will the federal government take on a permanently larger economic and social role than it has in the past — composed of largely the same plans and policies? Or will the federal role return to post-World War II norms with the prospect that the new revenues generated by economic growth will be available for new initiatives? This choice is not ideological; it is political. In a country that is increasingly polarized, it remains to be seen where the political margin lies.
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