Tax Policy Center estimate of a 10-year $6.2 trillion revenue loss is used to predict higher interest rates, and those higher interest rates prevent the economy from growing faster, which in turn vindicates the static assumption of a $6.2 trillion revenue loss.
The circularity of this tangled fable is remarkably illogical. How could interest rates remain higher if private investment is crowded out leaving GDP growth unchanged?
The TPC tells a similar story about the House Republican tax plan. “Although the House GOP tax plan would improve incentives to save and invest, it would also substantially increase budget deficits unless offset by spending cuts, resulting in higher interest rates that would crowd out investment [emphasis added].” This too is an unsupported assertion. The TPC analysis predicts more private savings and therefore cannot simply assume deficits “would crowd out investment.”
The TPC’s stubborn notion that deficits raise interest rates dates back to a 2004 Brookings paper by Bill Gale and Peter Orzsag which estimated that “a sustained 1 percent of GDP rise in projected deficits would raise current yields by between 20 and 60 basis points, holding other factors constant.” In reality, actual and projected deficits have been much higher since 2004, yet bond yields fell dramatically. Japan routinely runs deficits of 5-7% of GDP with bond yields near zero.
The TPC alludes to the Penn-Wharton Budget model as though it is less Keynesian than their own (or that of the CBO). Yet the architect of that model, Kent Smetters argues that “tax cuts will lead the government to increase its borrowings, which in turn will increase the debt with the general public… Such debt will compete with private capital for household savings and international capital flows.” Like the TPC, Smetters first assumes the TPC static revenue loss is a meaningful number and then goes on to theorize about U.S. and foreign investors making fewer private investments because they (rather than U.S. and foreign central banks) must supposedly purchase more Treasury bills and bonds. Like the TPC model, the Smetters model also assumes potential output is unaffected by greater investment and work effort, so faster growth in the first few years must supposedly be offset by slower growth after 2024. Assume slow productivity gains and slow labor force growth, then slow GDP growth must (by definition) be the best we can do.
The Tax Policy Center estimates that the revised Trump plan would reduce revenues by 2.6% of GDP (regardless of economic growth). But it is important to realize that this “loss” is only in comparison with the rising CBO baseline. With no change in tax policy, the CBO projects the individual income tax will rise faster than GDP every year with no adverse effects on the economy. The individual income tax is projected to be 8.5% in 2017, then 8.7% in the following year, then 8.9%, 9.1%, 9.2% 9.3%, 9.4%, 9.5%, 9.6%, 9.7%, 9.8% and so on.
This ever-increasing tax burden is mainly because ever-increasing real wages will supposedly push more and more families into the 35% and 39.6% tax brackets, and also subject them to Obamacare’s 0.9% surtax on labor and 3.8% surtax on investments.
If revenues from the individual income tax instead remain at the unusually high 2003-2015 level of 8.3 percent of GDP (which would beat any previous 10-year average), then revenues over the next ten years will turn out to be $2.62 trillion smaller than the CBO projects.
In other words, nearly half of the Tax Policy Center’s $6.2 trillion static revenue loss from the revised Trump plan is due to the CBO’s implausible assumption of endless automatic tax increases, rather than to a huge “tax cut” (at least in the House GOP plan) when compared with taxes we have actually been paying.