Why debt from GOP tax cuts might impose a painful price

When House Republicans proposed their tax-cut plan last week, critics noted that it came with a towering price: It would swell the nation's debt by $1.5 trillion at a time when the economy is already faring well on its own and a vast generation of retiring baby boomers threatens to strain the Social Security and Medicare programs.

Continue Reading Below

President Donald Trump and Republicans in Congress argue that their plan, which would shrink the corporate tax rate and end taxes for most wealthy estates, would accelerate economic growth. It would do so, they say, by leaving more after-tax money for businesses to invest and to increase pay for their employees, who would then spend more and help invigorate the economy.

Kevin Hassett, chairman of the White House Council of Economic Advisers, has contended that the proposal to cut the corporate tax rate to 20 percent from 35 percent could, by itself, enlarge the economy by up to $1.2 trillion over the long run and eventually add $4,000 a year to average household income. Those claims were promptly dismissed as wildly optimistic by Democrats and many economists.

Adding to the government's debts poses risks, too: More debt could drive interest rates up as the government competes with private borrowers for credit. It could also eventually require cuts to popular spending programs. And it might leave policymakers with less ammunition the next time a recession strikes.

For now, the American economy is already gliding along at a decent pace. Growth has come in at a solid annual rate of 3 percent or better in each of the past two quarters. Employers have added jobs for a record 85 straight months. Corporate profits are strong. And the unemployment rate is 4.1 percent, its lowest level in nearly 17 years.

All of which is why some analysts argue that big tax cuts aren't needed now — even if they would help stimulate the economy, which is far from sure. Instead, policymakers and lawmakers could be capitalizing on good times to take a whack at the government's surging debt — $14.8 trillion (or $20.5 trillion if you include including debts the government owes itself).

Continue Reading Below

In a report last month, the International Monetary Fund concluded that many wealthy countries could afford to pare their deficits by raising taxes on the wealthiest without jeopardizing economic growth.

"We should be running surpluses when the economy is strong," William Gale, co-director of the Tax Policy Center, wrote in a blog post after the tax plan was released last week. "The proposed tax cuts would add to an already unsustainable long-term fiscal situation."

Mark Zandi, chief economist at Moody's Analytics, says the cost of the Republicans' proposed tax cuts would add considerably to the federal debt burden, which now equals 75 percent of U.S. gross domestic product, the broadest measure of economic output. By 2027, Zandi says, that burden would equal 97 percent of GDP with the tax plan and 87 percent without it.

"It's an unsustainable debt path," Zandi says.

The government runs a deficit when it spends more than it collects in taxes and a surplus when it takes in more than it spends. Government debts are the cumulative result of years of deficits and surpluses.

The federal budget last recorded a surplus in 2001. Deficit spending returned when the dotcom bubble burst, knocking the economy into recession in 2001, and the administration of President George W. Bush pushed through tax cuts in 2001 and 2003.

The Great Recession of 2007-2009 — and the anemic recovery that followed — drove deficits to new heights, shrinking tax collections and increasing government spending on such safety net programs as food stamps and unemployment aid. President Barack Obama's $862 billion emergency stimulus program in 2009, made up of spending increases and tax cuts, widened the budget imbalance.

The federal deficit peaked at $1.4 trillion in the recession year of 2009 and began to decline as the economy strengthened. It dropped in 2015. Then it started rising again, hitting $666 billion in the fiscal year that ended Sept. 30.

Now, even though the economy is healthier, the budget is still under strain.

A key reason is demographics. The baby boom generation is trudging into retirement and collecting Social Security and Medicare. Nearly 61 million Americans were enrolled in Social Security last year, up from 49 million a decade earlier. Social Security spending is projected to rise from 4.9 percent of GDP this year to 6 percent in 2027, according to the Congressional Budget Office.

Likewise, spending on big health care programs is expected to rise from 5.4 percent of GDP to 6.9 percent over the same period as more older Americans tap Medicare, the CBO says.

Then there is the effect of interest rates: Decades of historically low rates have allowed the government to borrow cheaply. Those days may be fading. The Federal Reserve, which kept short-term rates near zero during and after the Great Recession, has reversed course as the economy has improved.

Longer-term rates are also expected to rise as the government debts grow, thereby, worsening the problem. Treasury will likely have to pay higher rates to keep investors buying its expanding debt. The CBO foresees federal interest payments rising from 1.4 percent of GDP this year to 2.9 percent in 2027.

Zandi warns that rising rates would offset any economic benefits from the GOP tax plans.

Rising deficits could also intensify pressure on lawmakers to cut popular programs. Senate Republicans have passed a budget resolution that calls for $5 trillion in spending cuts over a decade, including $473 billion in cuts to Medicare and $1 trillion in cuts to Medicaid, the health care program for the poor. Still, senators have no specific plans yet to carry out those politically toxic cuts.

Another worry: Increasing the debt will leave policymakers less room to combat the next recession with tax cuts, spending increases or both. The current economic expansion is in its ninth year — the third-longest in U.S. history — and a downturn at some point is inevitable.


AP Economics Writer Josh Boak in Washington contributed to this report.


Follow Paul Wiseman on Twitter at https://twitter.com/PaulWisemanAP