The GOP's New Tax Plan Will Affect Everyone, But Will It Grow The Economy?

The hubbub over the Republican tax plan has died down some since it passed, but the bill isn't forgotten — not by a long shot.

Many Americans will see the effects already this year, when the IRS gives employers new guidance on how much money to withhold from people's paychecks. And you can bet it will be a major talking point in the 2018 midterm elections, supplemented by regular presidential tweets touting new hiring and higher stock prices.

Against that backdrop, we received a wave of listener inquiries that boil down to one basic question: Will the recently passed Republican tax plan grow the economy? We decided to try to give these listeners a (relatively) simple answer.

You may already know where this is going. This question asks for a prediction, but also about economics. So a simple yes or no is impossible.

But we can make some educated guesses, based on what smart people have said about this tax plan.

A bump, then a lull

Fortunately, someone has already asked a version of this question to a whole mess of economists at once. The University of Chicago's Booth School of Business often polls top mainstream economists on issues of the day. And on this question, those economists leaned heavily away from saying that the bill would create long-term economic growth.

The Booth School asked economists in November whether they agreed that tax plans "similar to those currently moving through the House and Senate" (this was before the tax bill was passed, remember) would leave GDP growth "substantially higher a decade from now than under the status quo."

Of the 42 economists, just over half (52 percent) disagreed — that is, they don't believe the plan would lead to faster economic growth. Thirty-six percent were uncertain. Only 2 percent agreed. (The remainder did not answer.)

So they weren't unanimous, but almost none of them had confidence that the tax plan will lead to "substantial" economic growth.

This runs counter to Republican messaging during the tax fight that it could boost GDP by an average of 0.4 percent per year over the next decade. While the bill was being crafted, multiple expert analyses of the tax plan agreed that it would fall far short of that kind of growth.

But let's start at square one. The idea that tax cuts would create growth isn't at all wrongheaded. It makes sense that giving people (or businesses) some extra dollars through the tax code would lead them to spend more, speeding up the economy.

And different tax cuts affect the economy in different ways. In a 2012 report, Mark Zandi, chief economist at economics research firm Moody's Analytics, estimated the effects of various policies.

At that time, he found that a temporary child tax credit passed in 2009, for example, boosted GDP by $1.38 for every dollar in revenue lost on that tax cut. A payroll tax holiday came in at $1.27. Meanwhile, extending the Bush tax cuts came in at 35 cents for every revenue dollar lost, and cutting corporate taxes came in at just 32 cents.

So what does Zandi think of this tax plan — will it create growth?

"Not much," he said. "It's a pretty costly way to not go very far."

In his view, the tax plan will create a temporary sugar high that will taper off after a couple of years.

"The economy will experience stronger near-term growth in 2018 and 2019 with the stimulus created by deficit-financed long-term tax cuts," he said. "That will generate temporary growth. But it will also result in higher interest rates."

There are a few reasons why that growth will fall off. One, as Zandi suggested, are those higher interest rates. What he's saying is that if and when the tax plan creates that new growth, the Fed will raise interest rates, which they took down to near-zero in the Great Recession to boost the economy. Since then, central bankers have slowly inched that rate upward, though it's still well below where it was pre-recession.

All of which is to say that the Fed is already carefully weighing when to tighten policy, and a burst of new growth from the tax plan could mean the central bank would want to tighten Fed policy sooner.

On top of that, the job market looks good, the stock market looks good, GDP growth has been solid recently — there's just not a lot of room for improvement. And that initial burst of new demand in the economy won't last — it will fall off. Other boosts — say, in labor supply or investment — won't make up for it, according to a report from the Tax Policy Center, a D.C.-based think tank that has been critical of the tax plan.

"I expect it to be beneficial," said Doug Holtz-Eakin, president of the right-leaning American Action Forum and a director of the Congressional Budget Office under George W. Bush. "I don't expect it to be very long-lasting, because there's not very much room to grow there."

Figures from the Tax Policy Center square with that, predicting that the new tax regime will boost GDP in 2018 by an additional 0.8 percent. But then after that, it would eventually taper off — by 2027, the bill would provide no additional growth.

That drop-off toward the end of the 10-year window is in large part because many of the bill's provisions expire at the end of 2025.

Were Congress to extend those provisions — assuming there were even the political will in eight years to do that — it could boost the economy. But then, that would cost money. And that cost would come on top of an already steep price tag.

Currently, the plan is projected to cost around $1.5 trillion over 10 years. Adding that much or more to the debt, some economists fear, will hurt the economy by bumping up interest rates. The idea here is that higher interest rates would mean less borrowing and spending throughout the economy.

"The problem with making it permanent is it's really going to help you in years 9 and 10, but it's actually going to really hurt you in years 30 through 32," said Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget, which advocates for smaller deficits and debt. "If you make it permanent, instead of adding $1.5 trillion to the debt this decade, it's going to add $2 trillion to the debt this decade and then another $2 or $3 or $4 trillion next decade and another $2 or $3 or $4 trillion the decade after that."

So there's a good case to be made that there will be initial growth, but that it will disappear — or nearly disappear — in the medium-term.

The tax bill wasn't just about rates

But there's more to the tax bill than just tax cuts, Holtz-Eakin of the American Action Forum stresses.

"The more lasting and important contribution are the reforms, as opposed to pure tax cuts," he said. "The most important thing the bill does is change dramatically the way the U.S. taxes business activity."

The plan drastically lowers the corporate tax rate — down from a top rate of 35 percent to 21 percent. But there's another big change it makes on the corporate side: It changes the U.S. from a worldwide system, one in which a company's foreign and domestic earnings alike are taxed, to a territorial corporate taxation system, in which just domestic earnings are taxed.

This brings the U.S. more in line with other major world economies. Proponents of this policy believe that this helps level the playing field with other countries and encourages more companies to be based in the U.S., among other benefits.

To Holtz-Eakin, this is more important for sustained economic strength than the tax cuts. He believes it will mean modest, but meaningful and lasting growth that will compound over time — well beyond the 10-year budget window.

Still, it's not clear to everyone that it will be that meaningful.

"Moving to a territorial system is a good idea, but that is really on the margin," Zandi said. "When they're making investment decisions, they're looking at lots of different factors."

He points to trade and energy policy, as well as where businesses can find the workers they need. In addition, he notes that other nations might find ways to change their tax systems in turn to compete with the U.S.

Put all of this together, and there's no way to give a firm yes or no that answers this question fully.

The best answer to this question seems to be a highly qualified yes. Yes, the tax bill will likely spur some economic growth. But there's good reason to think that 1: that growth will be heavily front-loaded, and 2: the longer-term growth change over what the U.S. would have had without the tax plan will be modest, or even minimal.

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