The US Urgently Needs the Tax Reform to Close the Recovery Gap
The US economy expanded in the second quarter of 2017 by more than double the pace shown in the first quarter, reducing concerns about stagnation or even a forthcoming recession.
Gross domestic product rose at a 2.6% annualized rate from the previous quarter, while first-quarter growth was revised down to 1.2% from 1.4%. The biggest drivers of growth were consumer spending, the biggest part of the economy, which rose 2.8%, while non-residential fixed investment increased 5.2%, adding to growth. After years of no increase in capital expenditure, business investment in equipment rose 8.2%, while net exports also added to growth.
All these figures are relevant, but there is one that is significantly more important.
The recovery growth gap compared to other recoveries since 196o has been set at $1.67 trillion. That means the weakest recovery in recent history. The Federal Reserve expects 1.9% growth for 2017 going to 2% in 2018, the weakest relative to potential and previous recoveries.
All of this is after a massive $4.7 trillion monetary stimulus and $10 trillion in new debt (a fiscal deficit increase of $13 trillion at State, local and Federal level).
As such, the concern is that the economy is not doing what it could do in terms of growth, delivering on real wage growth and creating better jobs.
There is a clear cap on growth set from excessive taxation and high government debt. The US continues to suffer one of the highest corporate tax rates, and disincentives to investment persist. The evidence of the positive impact on growth, jobs, and wages of lower corporate taxes has been published in many studies. The example of more than 200 cases in 21 countries shows that tax cuts and expenditure reductions are much more effective in boosting growth and prosperity than spending increases. The studies of Mertens and Ravn (The dynamic effects of personal and corporate income tax changes , 2012), Alesina and Ardagna (Large changes in tax policy, taxes versus spending , 2010), Logan (2011), or the IMF conclude that in more than 170 cases, the impact of tax cuts has been much more positive for growth.
You might think that the US is doing just fine with the current system, but that would be missing the enormous potential of the economy. Consumption is the largest part of the economy and would benefit from returning to taxpayers their hard-earned money after $1.5 trillion in new taxes in the past eight years. Additionally, we cannot expect companies to increase capital expenditure in the US to recover Capex investment and create better-paid jobs if the tax burden stands almost 10 points above the OECD average and it is almost impossible to generate a Net Return on Invested Capital above the weighted average cost of capital, now that interest rates are rising.
The two main components that will save the US economy from entering a recession due to the boomerang effect of incorrect stimulus and excessive debt will be consumption and investment. None of them can reach their full potential, and offset the inevitable slowdown in other components, without a tax reform aimed at supporting growth. Tax cuts and supply-side measures are badly needed after demand-side, high debt and government intervention have left such an enormous recovery gap.
An overly optimistic reading of these GDP figures misses the point. The US needs to grow closer to its immense potential or face the consequences when global forces negatively impact the economy.
The US needs to be prepared, and deliver more robust figures, before the Chinese slowdown, the backlash of European stimuli and the sudden stop in emerging markets affect its domestic economy.
The US cannot afford to be complacent with these growth figures because it needs to think of the future, and the only way to lighten the burden of debt that cripples the economy is by boosting growth and reducing spending.
Cutting taxes does not just make economic sense, it is social justice. The US government needs to return to taxpayers the effort that they have made lifting the country from the depression.
Daniel Lacalle is Chief Economist at Tressis SV, has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)
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