President Donald Trump in recent days has stirred up debate by proposing a 10 percent middle-class tax cut. The discussion often involves an assumption that the tax reform enacted late last year was a failure, increasing the federal deficit and having a negligible effect on the economy. The assumption is wildly premature, if not completely wrong.
Critics seized on the Treasury Department’s recent report that the federal deficit grew from $666 billion in fiscal 2017 to $779 billion in the just-ended fiscal year. Here was proof, we were told, that the 2017 tax cuts are already reducing federal revenue and increasing the deficit. In fact, the tax cuts are already improving economic growth, and they will return greater revenue as the business investments stimulated by the cuts begin bearing fruit over the next two years.
Yes, the federal deficit increased by $113 billion in fiscal 2018 (which ended Sept. 30). Revenue increased by $14 billion, a 0.4 percent rise from 2017, while federal spending increased by $127 billion, a full 3 percent increase and nine times the increase in revenue. But the numbers are misleading.
Let’s put aside, for now, the possibility that this is a problem of too much spending, not too little revenue. Critics of the tax reform argue that the cuts are at fault because federal revenue otherwise would have been high enough to cover the spending increase. For support, they point to a Congressional Budget Office forecast from June 2017 under then-existing law (before the tax cuts) projecting $200 billion more in tax revenue for 2018 than the government actually collected.
Notably, the CBO predicted “particularly strong” tax revenue growth for 2018 because it believed investors were anticipating a capital-gains tax cut and planning to sell off holdings when it occurred. The CBO, therefore, projected a burst in capital gains tax receipts. Those who claim that the forecast relied on pre-tax cut rates ignore the CBO’s assumption that Congress would cut capital gains rates. That tax cut and the accompanying burst in capital gains revenue never occurred. Had Congress reduced capital gains rates, revenue would have increased as the CBO projected.
Yet, even assuming that tax revenue would have been higher in 2018 but for the tax cuts, it is far too early to judge them a failure. The CBO’s 2017 forecast assumed a 2 percent gross domestic product growth rate for calendar year 2018. Following the tax cuts, GDP grew at a much-improved average rate of 3.2 percent for the first two quarters of calendar 2018 and the CBO is now projecting 3.3 percent GDP growth for the entire year. Increased consumer spending, a direct result of the tax cuts, has been the primary driver. With more people working for higher wages and taking home more of what they earn since the IRS reduced withholding rates in February, increased consumer spending makes perfect sense.
However, increased business investment, the other side of the tax benefits coin, has yet to show a significant impact on GDP because realizing the benefits takes longer. For example, in the business sector where I was a chief executive for more than 16 years, if restaurant owners decide to open new locations based on the increased profits they expect to receive from tax cuts, they would first have to find the right real estate. The owners would then need to negotiate a lease or a purchase, obtain the required zoning approvals and permits, hire contractors, build the restaurants and staff them. That can take up to two years – more in states such as California where zoning and permitting requirements are extensive and onerous.
No matter the sector, there are lead times before employers and workers can reap the rewards of a new investment. Those rewards from the tax cuts enacted late last year are now on the way; it is unreasonable to assume that the economy would realize them within the first nine months following the tax cuts passage.
Gains in jobs, wages and take-home pay are already showing the benefits of tax cuts, and consumers are, in turn, driving economic growth. But the best is yet to come. As the additional benefits of business investment are realized, those gains will only increase, as will the tax revenue those investments produce. Nonetheless, despite revenue increases that will flow from the tax cuts in the future, the federal deficit will begin to decrease only when Congress gets serious about reducing spending.
Andy Puzder is the former chief executive of CKE Restaurants and author of ‘The Capitalist Comeback.’ © 2018, Washington Post Writers Group.