The Tenuous Logic Behind Republicans' About-Face on Debt

By Greg Ip Features Dow Jones Newswires

Throughout Barack Obama's eight years as president, Republicans hammered relentlessly at the horrors of debt. In 2011 they took the country to the brink of default because they didn't want to raise the statutory debt ceiling. Last year candidate Donald Trump repeatedly ripped Mr. Obama for doubling federal debt.

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Yet in their drive to overhaul taxes, President Trump and his congressional allies are about to make the trajectory of debt even worse.

Financing tax cuts with deficits isn't the end of the world: There are economic arguments for doing so, though now isn't the optimal time for them, which I will get to. Moreover, Republican leaders aren't making these arguments. Instead they rely on a far more tenuous case: Lower tax rates will unleash so much new economic activity and thus added tax revenue that, contrary to history and mainstream economic opinion, the debt actually won't rise much, if at all. It's a politically convenient face-saver, but it undermines a process Republicans themselves put in place to minimize the abuse of such reasoning.

Though Washington's attention is on the tax reform principles Mr. Trump and congressional leaders are unveiling Wednesday, the more substantive decision came last week when Republican senators Bob Corker of Tennessee and Pat Toomey of Pennsylvania agreed that next fiscal year's budget resolution would let tax reform add $1.5 trillion over 10 years to deficits (roughly 0.6% of gross domestic product). Mr. Trump can support that, administration officials said Wednesday.

How can that be justified? One way might be to argue that the economy needs stimulus, especially if the Federal Reserve is hamstrung because interest rates are near zero. But unemployment is at 4.4%, likely near as low as it can go without raising inflation pressure, and the Fed is raising rates. If the central bank thinks a tax cut will overheat the economy, it will raise rates even more quickly, potentially snuffing out any benefit to growth.

A related argument: With government bond yields at just 2.3%, it's OK to borrow more to finance investments that raise future output. Liberal-leaning economists like Larry Summers make this argument in favor of public infrastructure. "Supply-siders" like Mr. Toomey make a similar case: that lower tax rates bolster private investment and output, and that makes debt more acceptable.

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But permanently widening deficits is risky when the publicly held federal debt, now 77% of GDP, is on track to hit 91% in a decade as aging baby boomers draw on Social Security and Medicare. A $1.5 trillion tax cut would push that to 100%, according to the Committee for a Responsible Federal Budget, a watchdog group.

Mr. Trump and congressional leaders have said they're going to shrink, not expand, deficits. Even Mr. Corker, a deficit hawk long concerned about the trajectory of the debt, says if tax reform is truly growth-oriented, the deficit impact actually will be minimal.

His logic: The budgeted $1.5 trillion in revenue loss, besides including the cost of extending some existing tax breaks, is a "static" number that ignores any added economic activity and thus tax revenue that the lower rates might generate.

Republicans have long thought static scoring exaggerated how much tax cuts add to the deficit. So in early 2015 Paul Ryan, now speaker of the House of Representatives, directed the Congressional Budget Office and Joint Committee on Taxation, nonpartisan scorekeepers for Congress, to "dynamically score" tax cuts to incorporate their feedback to the economy. This was economically justifiable, though again politically convenient.

The problem is the JCT and CBO may not tell Republicans what they want to hear. Mr. Trump says he'll boost long-term economic growth by at least a full percentage point. House Republicans say their budget plan (which must later be reconciled with the Senate's) will raise growth 0.7 percentage point, yielding $1.8 trillion of deficit reduction over a decade.

There is little evidence from the last few decades that a tax rate cut raised underlying growth in the U.S. or any other advanced economy anywhere near that amount, once the vicissitudes of the business cycle are factored out. Debt rose as a share of gross domestic product after Ronald Reagan and George W. Bush cut taxes; it fell after Bill Clinton raised them. Independent economists think tax reform could boost growth by anywhere from 0.1 point to 0.6 point over a decade. JCT and CBO would likely be at the low end of that range since they believe higher deficits nudge up interest rates and crowd out private investment.

If so, Mr. Trump and Republicans are likely to solicit more flattering estimates. Mr. Corker has said he's open to this. But that undercuts the logic of involving the CBO and JCT, which is to provide analysis free of bias, including the president's. If legislators can cherry-pick their analysis, why wouldn't Democrats demand that increased health, education and child-care spending get credit for boosting wages and reducing incarceration costs, or that increased public infrastructure get credit for raising future productivity?

Mr. Corker insists he won't agree to "some crazy scoring mechanism" and may vote against a plan that doesn't meet his standards. As if to underscore his resolve, he announced Tuesday he won't run for reelection next year, the better to keep doing his job "thoughtfully and independently."

But Mr. Corker is just one vote. In the coming year, the fiscal rectitude he holds dear will for most of his colleagues take a back seat to the raw political imperative of getting a tax cut passed.

Write to Greg Ip at greg.ip@wsj.com

(END) Dow Jones Newswires

September 27, 2017 13:52 ET (17:52 GMT)