By Adding to the Debt, Tax Cuts Could Complicate Next Downturn

In enacting a tax cut that is projected to raise annual federal-budget deficits to nearly $1 trillion in the coming years, Washington could be trading more growth now for the risk of more pain down the road.

The U.S. government has traditionally reduced interest rates, boosted spending or cut taxes when the economy contracts. Budget analysts warn that future policy makers would have less ammunition to take such actions during the next recession because tax changes are projected to push already-rising national debt levels even higher. That could make the next downturn more severe than it would otherwise be and put added pressure on the Federal Reserve to respond to future crises.

“While I’m always for reforming the tax code, the timing of this thing doesn’t make any sense,” said William Hoagland, a former budget adviser to Senate Republicans now at the Bipartisan Policy Center in Washington, referring to the tax cuts signed into law by President Donald Trump in December. “If we do actually have a downturn in the economy, what are the levers available from the federal government’s perspective?”

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Even before last year’s $1.5 trillion in tax cuts, deficits were projected to swell over the coming decade due to the costs of caring for an aging population. An older population will require more spending on Medicare and Social Security and could lead to slower growth rates in personal income and household spending.

Having less fiscal flexibility doesn’t just provide less firepower against downturns. It also creates thornier trade-offs in annual budget fights, illustrated by the partial government shutdown that began Saturday. Other priorities, such as rebuilding the military, could become casualties. The U.S. will spend more on interest payments than on the military by 2027, according to projections by the Congressional Budget Office.

The White House and congressional Republicans say stronger growth will boost tax receipts that will eventually make up for revenue shortfalls from tax-rate cuts. But they haven’t released detailed analyses buttressing that argument, and estimates by the Joint Committee on Taxation, the CBO and many private analysts contradict those claims.

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A new analysis, co-authored by Christina Romer, a top economic adviser to former President Barack Obama, found fiscal space matters in a downturn. The study evaluated the economic performance of 24 developed nations after financial shocks since 1967. The study found countries with lower debt-to-GDP ratios responded more aggressively, and countries that used all of their available tools to cut rates and stimulate growth saw modest declines in output. Countries without the space to ease fiscal or monetary policy suffered larger contractions.

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“We are living in a singularly brittle context,” said Lawrence Summers, who was Treasury secretary in the Clinton administration and an adviser to Mr. Obama. “We do not have a basis for assuming that monetary policy will be able as rapidly as possible to lift us out of the next recession.”

https://www.wsj.com/articles/by-adding-to-the-debt-tax-cuts-could-complicate-next-downturn-1516549269