Federal tax cuts could accelerate inflation, drive deficit higher (letter) | VailDaily.com

Federal tax cuts could accelerate inflation, drive deficit higher (letter)

In December, President Trump signed the largest tax cut in history — seemingly a great way to boost real GDP, but maybe not good given the timing and associated policy decisions.

One of the basics taught in Economics 101 is that GDP growth is a function of productivity growth, labor force growth and inflation. The huge reduction in corporate taxes should spur capital spending, thereby fueling productivity growth. However, the productivity gains will be felt in the long run, not in the short run. As for labor force growth, unfortunately the tax cuts are coming at a time of virtual full employment, at a time when immigration is being discouraged, and at a time when illegal immigrants are being deported. Labor shortages seem inevitable.

Wage rates will unquestionably rise… but so will inflation. Inflation fears eventually will spook the bond and stock markets. Without offsetting spending cuts, the federal deficit will balloon, putting additional upward pressure on interest rates. Rising interest rates and possible stock market malaise will crimp housing starts, auto sales, and overall consumer spending. Real GNP growth will not reach the targeted 3.5 percent level, resulting in higher than projected budget deficits and greater government borrowing — both putting additional upward pressure on interest rates. Inflation may be further exasperated by more restrictive trade policies. Booming global economies might bail us out, but that seems unlikely given the extent of global linkage these days.

Not a pretty picture! I’m usually very early in my calls on the economy and markets so all this may take months or a year or more to materialize. But, unfortunately I do not see a happy ending.

How the Trump administration might respond if this scenario begins to play out is even more scary. Policy options to avoid a huge budget deficit, inflation and possibly a recession are limited. Traditional fiscal and monetary stimulus would only further exasperate rising inflation and interest rates. The GOP and President Trump might do nothing — just declare victory and let the next Congress and administration deal with it. The president can blame the bad economy on the Treasury, the Democrats, “bad” trade deals he inherited, or fake news.

That may be the best scenario we can hope for. It gets really scary if the president feels he needs to act in order to “win.” What might President Trump resort to in response to a bulging federal deficit, rising interest rates, and possible recession? One worrisome alternative is the sale of federal assets such national forest land, national parks, airports, bridges, etc. He has already headed down this path with his $1.5 trillion infrastructure proposal. (As a side note, the major beneficiaries of asset sales probably would be Goldman Sachs, the Russians and the Chinese.) A second alternative is to divert the news and rally his base with conflict — military, trade or “corruption” in some segment of government.

Fortunately, I’m neither a Ph.D. economist nor a politician so perhaps I’m wrong about all of this. Let’s hope so!

Or, perhaps President Trump is a good enough salesman to convince the nation that living on debt and renting our assets is a good thing. Time will tell! So far the president has been very successful declaring victory regardless of the actual outcomes.

Bill Bethke


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