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home : most recent : statewide implications May 26, 2018


4/30/2018 10:22:00 AM
COMMENTARY: Tax cuts and new tariffs aren't complimentary

Larry DeBoer, Purdue agriculltural economist. His column appears in Indiana newspapers.

The Congressional Budget Office came out with their ten-year economic and budget projections earlier this month. The CBO is nonpartisan, which means they don't have a political axe to grind. They're just trying to get the right answer.

The report is usually issued in January, but it was delayed this year because of the big tax cut in December. It took a while to figure out the effects of this big policy change. Let's look at the CBO's projections, and what they might mean.

The tax cut is intended to increase the profitability of business investment in buildings, equipment, and new technology. With more investment, workers would have more and better tools to use, and productivity would grow faster. The tax cuts are meant to increase incentives to work, too, as people get to keep more of their take home pay. That should increase the labor force. CBO thinks the economy's output will grow 3 percent this year, and average 1.9 percent growth per year over the next ten years. Before the tax cut they had projected 2.2 percent for 2018 and 1.8 percent over ten years.

Tax cuts increase after-tax income, so people will spend more, too. The spending will out-pace the increase in production, which ought to increase inflation. Spenders will bid up the prices of the things they want to buy. The Federal Reserve would have to raise interest rates to keep inflation from rising. CBO thinks that the Fed's policy interest rate (the federal funds rate) will be 3.8 percent in 2020, up from last year's projected 2.9 percent.

CBO says that the Federal budget deficit will increase as a result of the tax cut. It was already set to increase because baby boomer retirement would add to Social Security and Medicare payments. But instead of rising to 3.6 percent of GDP by 2020, CBO now thinks the deficit will rise to 4.6 percent of GDP that year.

Bigger deficits mean that the U.S. Treasury will have to sell more Treasury bonds. Bonds are promises to repay principal plus interest in exchange for money now. That's how the Treasury borrows the difference between what we spend and what we collect in taxes. The deficit is projected to rise to $1 trillion in 2020, and keep rising.

That's a lot of borrowing. Who will lend the money? Who will buy the bonds?

The Federal Reserve could buy the Treasury bonds. They could create new money and lend it to the Treasury. The Fed is unlikely to do that, though. These days they're selling some of Treasury bonds they own, to take money out of the economy and hold down inflation. The Fed is selling, not buying.

U.S. lenders could buy the Treasury bonds. That's where the Treasury borrows most of what they need, as banks, investment funds, insurance companies, and others buy bonds for their portfolios. As the Treasury buys more bonds, though, lenders have less money available to lend to private companies. The bigger budget deficit would reduce business investment in buildings, equipment and new technology - just the opposite of what the tax cut is trying to achieve.

International lenders could buy the Treasury bonds. We could borrow from people in other countries. The world loves our Treasury bonds. The bonds may pay low interest rates, but they're practically risk-free. In 242 years the United States has never missed an interest payment, and we're not likely to start now.

But the Treasury needs to borrow dollars. International lenders have euros, yen, yuan, pounds, and pesos. Where do international lenders get the dollars to lend? They get them when we buy their exports. We pay dollars, or we trade dollars into international exchange markets in exchange for other currencies. Some of those dollars are lent back to us to cover our budget deficit.

Now we're increasing our tariffs on imported goods. We'll be buying fewer imports from other countries. Our imports are other countries' exports. If we buy less from them, they'll have fewer dollars to lend back to us.

That means we'll have to borrow more from our U.S. lenders, which will subtract more from business borrowing and investment spending. The tax cuts and the tariffs work at cross-purposes.

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Editor, John C. DePrez Jr.; Executive Editor, Carol Rogers; Publishers: IBRC and IAR


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