WASHINGTON, August 2, 2017 – In May, President Trump introduced his first budget to Congress. In it, he wants to change the tax code and significantly reduce spending on entitlement programs. Trump claims the actions in his budget would reduce the deficit and eventually lead to a balanced budget by 2027.
The Congressional Budget Office (CBO) disagrees.
The CBO reported that Trump’s budget would produce an annual deficit of $720 billion in the year 2027. In fact, over the next 10 years, the CBO projects that the course Trump has proposed will increase the public debt by $3.7 trillion above current estimates, over the next decade.
Is Trump right? Or is the CBO right?
Any projection about future economic activity is based on some assumptions. While actions taken, like cutting taxes or increasing spending can be initially quantified, the effect on other components of the economy requires developing assumptions.
For instance, in 2011 Congress passed a payroll tax holiday that reduced the employee’s social security tax rate from 6.2% to 4.2%. While it is easy to calculate how much additional cash workers will have, the total effect on the economy is tougher since assumptions must be made.
The 2% reduction in the Social Security tax rate added about $10 billion to workers’ paychecks monthly. Congress assumed that most, if not all, of the funds, would be spent by consumers and would, therefore, stimulate the economy. On average, the $20 per week additional take home pay is not enough to save, they assumed.
On average, the $20 per week additional take home pay is not enough to save, they assumed.
Based on that assumption, the CBO said that the social security tax cut would indeed stimulate the economy so that growth would increase to between 3% and 3.5%, and continue at the rate for the next few years.
Faulty assumptions lead to faulty conclusions.
It turned out that Congress’s assumption was faulty so that the CBO estimate was very inaccurate. Because Americans carry large personal debt and because there was so much uncertainty in the economy, Americans used almost all of the tax cut to reduce their debt rather than spend the money to stimulate the economy.
The result was that the economy grew by about a 2% rate that year and stayed there well into the future.
The CBO agrees with Trump’s budget that makes the assumption that about $4 trillion can be cut from projected government spending over the next decade.
The difference between the estimates is that Trump assumes his proposed tax cuts will generate enough growth so an additional $2 trillion in tax revenue will be raised in the next ten years. Trump assumes that the tax cuts, along with the business-friendly environment that Trump is creating, will accelerate economic growth, perhaps doubling current growth rates.
Without specifics, the CBO assumes no additional growth from the tax reform plan. They argue Trump’s tax plan will likely reduce tax revenue by $1 trillion, not increase tax revenue.
CBO and Trump agree on some things.
Even though the numbers are different because of different assumptions, there is complete agreement in principle. That is, government spending must be contained and pro-growth tax policy must be implemented.
Since about half of all federal spending is for income maintenance programs like Social Security, Medicare and the other entitlements, those programs must be contained. This can only be done through reform.
Politically this will be very difficult. It appears that the only way to ensure long term stability to Social Security and Medicare is to increase the number of people paying into the system and decrease the number of people collecting benefits.
That can be done with a minimal amount of pain, by raising the retirement age. Social Security is phasing in an increase in the retirement age to 67. Medicare remains available to everyone on their 65th birthday.
Eventually, both ages will have to increase to at least 70. In the future, as medical science increases life expectancy, the age to collect will likely have to increase to 75.
That means more people will be working and fewer people collecting.
When social security was enacted in 1935, people could collect at 65 and had a life expectancy of 67, so they only collected for two years. According to the Social Security Administration (SSA), a man reaching 65 today can expect to live to 84. A woman can expect to live to almost 87.
The SSA further says that 25% of the current 65-year olds will live past the age of 90 with 10% living past 95.
Pro-growth tax policy also needed.
Both the CBO and Trump agree that a pro-growth tax policy is needed. Trump recognizes that high taxes slow economic growth. Low taxes promote economic growth. And the tax rate has to be low for all income earners, especially those at the higher end.
High tax rates on the highest income earners reduce the capital needed for growth. Over taxing the highest achievers is counter-productive, because without new capital it is difficult for the economy to grow. It’s that simple.
While estimates of the effects of economic policy differ, virtually every economist will agree the entitlement reform and pro-growth tax policies are needed to stimulate economic growth and solve our economic problems. Will the President and Congress be able to do this when the budget battle begins in September?
Will the President and Congress be able to do this when the budget battle begins in September?