When Trump’s Tax Cuts Run Out of Steam

by Wyoming Liberty Group Staff

As I have noted on a couple of occasions now, 2019 is shaping up to be a great year to start reforming government spending here in Wyoming. Two sessions in a row, the legislature has rejected massive tax hikes and even refused to appoint a commission to overhaul our tax system.

Time is ripe to talk about spending reform. But time is also short for such reforms to go from idea to law: as I explained recently, the Wyoming economy is weak and the fiscal clock is ticking on our state budget. If we do nothing proactively, we will inevitably reach the "Alaskan" panic point.

It has been suggested from time to time that we have no real reason to worry. After all, the U.S. economy is doing spectacularly well, isn't it?

Indeed, there are reasons to celebrate the Trump economy. For example, in the Wall Street Journal, Tuesday March 6 (p. A17, print edition), former U.S. Senator Phil Gramm and his co-writer Michael Solon explain:

For a midterm report card on the economy under President Trump, take a look at two recent government reports. The Commerce Department reported Thursday that real gross domestic product grew by 3.1% from the fourth quarter of 2017 to the fourth quarter of 2018 – the largest rise in 13 years.

The other government report referenced by Gramm and Solon is from the Congressional Budget Office (CBO). It says that according to their forecast, a "revenue residual" (whatever that means) will pay for 80 percent of the "projected cost" of the Trump tax reform.

We can disregard the strangely worded reference to the CBO report, although it might be worth pointing out that running a budget deficit close to four percent of GDP when we are at de facto full employment is not exactly a sign of long-term economic strength.

Two decades ago, under President Clinton, we were also at full employment. The federal budget was in surplus. And it was growing in excess of four percent per year.

Which brings us to the growth numbers in the Gramm-Solon article. There are two points to be made here, leading us back to Wyoming.

It is inaccurate to say that the 3.1-percent growth rate is a 13-year high. It is an annual growth rate, for sure, but it only represents growth in the fourth quarter. As such, it compares to every other annual growth number, for every single quarter.

We need to go no further back in time than to 2015 to find a 3.8-percent growth rate in the first quarter and 3.4 percent in the second.

There are a lot of misperceptions around the GDP numbers. Senator Gramm's contribution, unfortunately, adds to the pile, confusing a one-quarter growth figure with a growth figure for the entire year. The last-mentioned growth number was 2.9 percent.

Equally confusing is the debate over annual vs. annualized growth. Last summer, conservatives were quick to celebrate a GDP growth rate at 4.1 percent (revised 4.2), in some cases as if it was in fact annual growth. It was not. It was the annualized growth rate; see this article for an explanation of the difference.

So what does any of this have to do with Wyoming? The hyped-up growth numbers mislead many into believing that the U.S. economy is not only doing better than it really is, but that it is also providing some kind of macroeconomic air coverage over the Wyoming economy. It does not. Our government finances will not be saved by a strong-growing national economy.

To see why, let us get back to the Trump tax cuts and Senator Gramm's argument about their blessing. Those who celebrated the 4+ growth rate last summer did so in the same context. While the Trump tax cuts have been good for the U.S. economy, they were not the sword that would cut the Gordian knot. They have given us a temporary increase in GDP growth that we could use for good reforms, especially here in Wyoming, but not much more than that.

As we move deeper into 2019, the steam is going to come out of the current growth spurt. When that happens, Wyoming will be at the tip of the recession, ahead of almost every other state.

But how do we know that the tax cuts won't keep our national – and therefore our state – economy growing?

I have answered this question in several different steps.

On June 12, while explaining that the 2.8-percent growth rate in the first quarter of 2018 was a three-year high, I cautioned that private consumption was diverging from the trend of improving GDP numbers. Private consumption accounts for at least two thirds of GDP; when it lags behind the rest of the economy, it is a signal that the long-term trend in the economy is below where current growth rates are.

On July 28 I noted that the second-quarter growth rate was 2.85 percent, not the hyped-up 4.1 percent everyone was talking about back then. The difference, again, was that between annual growth and annualized growth.

On December 28, returning to the trend in private consumption, I analyzed the composition of the U.S. economy, explaining why a tax cut that benefits corporations is good but won't generate spectacular growth numbers. Contrary to what is often believed among conservative economists, investments do not drive economic activity. Private consumption does. Since private consumption is four times larger than corporate investments, it was easily predictable that the Trump tax cuts would not be the magic bullet that sustainably would put the U.S. economy back above three percent growth.

Alas, the BEA's GDP data for the whole of 2018 show that:

• GDP grew at 2.88 percent;
• Private consumption was up 2.64 percent;
• Business investments increased at 5.95 percent; and
• Government spending expanded at 1.52%.

I said all 2018 that three percent growth for the entire year was possible but not guaranteed. The growth-leading variable has been gross fixed capital formation – business investments – which means that American businesses have been expanding their production capacity (nonresidential investments). This happened in very good part thanks to Trump's tax cuts.

The problem is that once new production capacity is in place, businesses have to make money by using it for production. To make money on that production, they need a market. If private consumption is growing at a third of the rate of non-residential investments, it means that production capacity is growing faster than the absorption for which most of it is aimed. (A small share goes on exports.) In other words, the boom we have seen in the past year will fade away soon; we will probably see it in the GDP numbers for the first quarter of this year.

When the national economy runs out of tax-cut steam, it is going to have repercussions for the Wyoming economy as well. We better be proactive and start talking about how to move our state in the right direction.