The main feature characterizing policies proposed by President-elect Trump during the campaign, at the moment, is uncertainty about how and whether they will be implemented. …
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By Andrea Brasili is a Senior Economist in charge of providing analysis on macroeconomic issues.
In the following, we analyze the economic and budgetary implications of the four most likely measures proposed. We believe that Trump policies will be positive in the short-medium term, helping investments and productivity growth. The impact on the long-term is less clear in terms of climate change, social cohesion and global growth, but those are not taken into account in the below analysis . We have elaborated on Congressional Budget Office (CBO) projections (released back in August 2016) and on analysis from the Tax Foundation, a non-partisan organization that studies tax policy in the US. The base case is represented by the CBO projections, the static case computes the revenue-expenditures impact without considering the feedback on economic growth, and the dynamic case includes the retroaction of these measures on economic indicators.
1. Tax Reform. The reform of personal income taxation would consolidate the current seven tax brackets into three, with the lowest tax rate rising to 12% and the highest falling to 33% (they are, currently, at 10% and 39.6% respectively). On the corporate side, the tax rate would be reduced from 35% to 15% and manufacturing firms could choose between fully expensing capital investments and deducting interest paid. According to the Tax Foundation, personal income tax cuts would reduce federal revenues by around $1.75 trillion over 2017-2026 ($3 trillion if policy does not positively affect GDP and there’s no feedback effect on the budget) and corporate income tax cuts would decrease government revenues by $1.9 trillion over 2017-2026. Combined, the tax measures would stimulate the economy, bringing additional employment and increasing payroll tax revenues by around $600 billion. The Tax Foundation also estimates that fiscal expansion would increase GDP by between 6.9% and 8.2% at the 2026 horizon.
2. Spending. If Trump’s $1 trillion investment plan is entirely borne by the public, the budget impact will be meaningful. However, longer-run economic returns may be better, since these investments will be directed to items of little appeal to the private sector, such as maintenance and pure infrastructures. On the other hand, were the spending to be carried out in Private Public Partnership (PPP), the impact on the budget would be lower ($170 billion of additional outlays), but the return on longer-run productivity growth will be lower as well. PPP implies investment in projects that have a stable and certain flow of returns (like the toll of a bridge) and hence, a much narrower field than the possible spending on infrastructure of public interest (an obvious example is high-speed internet connections).
3. GDP Growth. A study of the Congressional Budget Office (2015) sketches the economic and budget impact of repealing so-called Obamacare. In the time window 2017-2026 the deficit would deteriorate slightly (+$140 billion). In particular, CBO estimates higher GDP growth of around 0.7% per year over 2022-2026, mainly resulting from greater incentive for people to enter the job market (increased labour supply) and to a possibly increased capital stock (and labor demand) due to lower contributions charged on employers.
4. Trade Policy. We considered a 45% tariff on Chinese imports and a 35% tariff on non-oil Mexican imports. We assume, over 2017-2026, a reduction of $600 billion of GDP due to lower exports which would mean a 15% reduction annually of exports to the two above-mentioned countries.
Effect of Trump Proposals on US Debt
Analysis on the following Trump campaign proposals: Tax cuts, infrastructure spending, tariffs and trade and repeal of the Obamacare.
Were all policies to be implemented, average nominal GDP growth would increase, in the period 2017-2026, from 3.9% (baseline level of CBO projections) to 5.0%. In addition, the average deficit would increase to 5.2% and debt held by the public would be 89% of GDP in 2026 (compared to 85.5% of the baseline projection) in a dynamic scenario.
The static case is much worse: the average yearly deficit would be 7.2% and end-year 2026 debt would be 109.6% of GDP. As to the timing, while the investment program will take time, especially if carried out in PPP, the tax cuts can be implemented quite quickly.
We estimate a potential increase of real GDP growth, mainly as a consequence of the corporate tax cuts, of 0.2-0.5 percentage points for 2017 (from 2.3% to around 2.7%-2.8%), which would increase employment by 0.6%-0.8% and, consequently, inflation by 0.1%-0.2%.
Overall, these proposed policies could be positive in that:
The investments allowance, corporate tax cuts and infrastructure investments can potentially boost investments and help productivity growth.
With negative real interest rates, increasing debt is currently not a major issue.
On the other hand, previous massive supply-side episodes were not very effective, productivity growth is not explicitly targeted, especially if investments are carried out in PPP, and fiscal multipliers (i.e., the impact on GDP of a change in taxes) are usually very small for an economy already running above potential.