Will the tax cut boost growth?

I am enough of a supply-sider to think the answer is “yes”, and enough of a realist to think the growth effects will be quite modest, maybe a couple tenths of percent per year over the next decade (mostly front-loaded).  Michael Darda recently provided a much better explanation than I can:

Our friend Scott Sumner often says “real economists don’t forecast, they infer market forecasts”. On this score, those who believe that the Tax Cut and Jobs Act will drastically ramp up growth typically point to the stock market gains YTD and then argue that a gush of capital will come flowing in as corporate tax rates fall. There are a few major problems here, in our view. First, we have had a global equity market boom in 2017, with markets in Europe and Japan up by similar magnitudes and emerging market equities up 30% YTD, outperforming the S&P 500 by 1000 bps. Surely, the TCJA cannot explain why emerging market equities are outperforming domestic equities as the latter are the ones supposedly being lifted by fiscal policy expectations. Moreover, if markets expected a “rush of capital” to come pouring into the U.S., why has the dollar basically done nothing as the tax bill’s chances of passage have become almost certain? Some argue that this is because the Fed is going to “accommodate” the tax cut, meaning that despite projections for higher deficits, they will not tighten more as a result. Well, this is very hard to square with the bond market, which shows no significant pop in real rates (which is consistent with the dollar story); hence, there is no big expected jolt to supply-side growth expectations and also very little movement in inflation breakeven spreads, which means no big expected pop to the demand side. If the tax cut were expected to be expansionary, and the Fed were expected to accommodate said tax cut, why is the yield curve continuing to flatten instead of steepening?  . . .

With all this in mind, why, you may ask, are we advancing a debt-funded tax cut at a time of near full employment, which will likely add at least an additional trillion to a net $10 trillion in cumulative deficits over the next decade (HT, Caroline Baum<https://twitter.com/cabaum1/status/942475783175655427>)? We do not know and no one in Congress has given a good explanation as to why.

I would add that the market forecast of the impact of new policies is the optimal forecast (pity we don’t have a RGDP futures market) and anything we observe subsequently will be less informative than the market prediction.  Recall my posts on how there is no “wait and see” with monetary policy initiatives.  You discover within 5 minutes almost everything you will ever know about the effectiveness of moves like QE.

I see the market response to the tax cut as being consistent with my view of “some effect, but modest”.  A lot like QE!



29 Responses to “Will the tax cut boost growth?”

  1. Gravatar of dtoh dtoh
    18. December 2017 at 09:11

    Looks to me like real 5 year rates are up 65bp since the election. Not sure how that translates into “no significant pop in real rates” …. unless you assume the election had no effect on the market’s expectation of a tax cut, and it was only 2 weeks ago that the market began to expect a tax cut.

  2. Gravatar of Randomize Randomize
    18. December 2017 at 09:17

    Agreed. There’s no good reason to believe that the fiscal multiplier isn’t near zero. The FED controls the size of the pie and the level of federal deficit only changes the ratio of private/public pie consumption (until the debt service comes calling).

    If the US really wanted to do something about competitiveness and get multinational firms to locate here, we’d stop trying to tax them on items that are made overseas, sold overseas, and never touch American soil. That policy does nothing except to push their headquarters elsewhere.

  3. Gravatar of Randomize Randomize
    18. December 2017 at 09:18


    What are long-term rates doing? The short-term rates are more reflective of the FED’s behavior than natural market forces.

  4. Gravatar of ssumner ssumner
    18. December 2017 at 10:03

    dtoh. Maybe, but how much of that was tax cut expectations? Right after the election there was all this talk about bigger deficits, an infrastructure push, etc. etc.

    Overall, I find Michael’s analysis to be pretty persuasive—I don’t see much happening in the US that is not also happening overseas. The flattening yield curve is also quite revealing.

  5. Gravatar of Kevin Erdmann Kevin Erdmann
    18. December 2017 at 11:13

    The corporate tax cut is a great example of your complaint about how too much debate on taxes is based on redistribution. The corporate tax cut may boost growth a little, as you say, but the main advantage is a fairness advantage low or zero corporate taxes gets rid of all the tax gaming and international cash flow tax management. It means the little startup in Salt Lake City is competing on an even tax playing field with Apple or Google. If the electorate weren’t obsessed with redistribution effects that for the most part are wrong or irrelevant when taking incidence into account, this would be an obvious point that one would think practically everyone could agree on.

  6. Gravatar of Scott Freelander Scott Freelander
    18. December 2017 at 12:15

    Also, inflation is up, which could mean much of the increase in rates is due to higher inflation expectations. I doubt Trump would brag about that, though he’s really dumb, so can’t put anything past him.

  7. Gravatar of Sam Sam
    18. December 2017 at 13:07

    Scott – I think it’s more fair to look at equity returns since November 9th, not since the beginning of the year, right?

    The U.S. markets were on fire the end of the year; you can’t just ignore that fact.

  8. Gravatar of Jim Glass Jim Glass
    18. December 2017 at 13:37

    “I am enough of a supply-sider to think the answer is ‘yes’, and enough of a realist to think the growth effects will be quite modest, maybe a couple tenths of percent per year over the next decade (mostly front-loaded).”

    Quoting Martin Sullivan of TaxAnalysts.org…

    First, let’s talk about the easy part: growth. The Joint Committee on Taxation reported that the House bill would increase the level of GDP by an average of 0.7 percent and the Senate bill would increase the level of GDP by an average of 0.8 percent over the 2018-2027 budget window. This means that if the sum of GDP over the decade was $1,000 without any tax change, it would be $1,008 under the Senate bill (JCX-66-17; and JCX-61-17).

    This way of reporting the effect of the bill on GDP tells us nothing about the pattern of changes in GDP because of the tax cut. This extra GDP could all be in the first year, all in the last year, spread evenly over 10 years, or be the result of a constant increase in the rate of growth. In the last case, this would mean the increase in the annual GDP growth rate would be 0.15 percent.

    The Congressional Budget Office forecasts an average inflation-adjusted GDP growth rate of 1.84 percent over the next decade (CBO, June 2017 projections). One interpretation — inaccurate, but reasonable and useful for our purposes — is that the JCT is saying that the Senate bill boosts the real growth rate of GDP to 1.99 percent. (The projected GDP growth in actuality is front-loaded because there would be some stimulus effect in the early years and some tax increases and more crowding out of private investment due to higher deficits at the end of the decade.)

  9. Gravatar of ssumner ssumner
    18. December 2017 at 14:30

    Kevin, Good point.

    Sam, You said:

    “The U.S. markets were on fire the end of the year; you can’t just ignore that fact.”

    Nor can I ignore the fact that foreign markets have been on fire, or that US markets were on fire when Obama was President and RGDP growth was slow, or that corporate tax cuts would boost equity prices even if they did not boost growth.

  10. Gravatar of Jeff Jeff
    18. December 2017 at 14:32

    Cutting the corporate tax rate means more after-tax earnings. That by itself is enough to raise stock prices even if GDP growth is not affected at all.

  11. Gravatar of Jeff Jeff
    18. December 2017 at 14:34

    Wow, Scott. It seems great minds do think alike!

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    18. December 2017 at 14:45

    Wouldn’t we expect long term after-tax earnings to be somewhat insensitive to tax rates? Even if it would take a decade or more for that rebalancing of aggregate returns to happen, it doesn’t seem to me that a tax cut would shift equity values by more than a few percentage points.

  13. Gravatar of Brent Buckner Brent Buckner
    18. December 2017 at 15:02

    Dr. Sumner, you wrote: “dtoh. Maybe, but how much of that was tax cut expectations? Right after the election there was all this talk about bigger deficits, an infrastructure push, etc. etc.”

    Presumably any infrastructure push expectations have faded away and are not a part of the now 65bp rise since the election.

  14. Gravatar of KevinA KevinA
    18. December 2017 at 16:12

    Look at Sumner, OWNING the supply side label. I thought economists considered supply-side economics to be a dirty term.

  15. Gravatar of dtoh dtoh
    18. December 2017 at 16:47

    Not sure how we know about yield curve behavior in the new world of persistently low inflation.

  16. Gravatar of anon anon
    18. December 2017 at 17:03

    It is hard to think that the market increases can be attributed to the tax reform when it was never certain that the reform would pass (just look at predictit markets), but still market volatility was at a record low.

  17. Gravatar of B Cole B Cole
    18. December 2017 at 17:14

    Possibly the federal revenue loss will be larger than expected, as many people will switch reported income from “personal“ to the lower top corporate or LLC rates.

    That may be good for growth.

    Perhaps the GOP has been right all along. “Deficits do not matter.”

    The Bank of Japan has been buying back national debt for years without inflationary consequence.

    If a central bank maintains a façade that it will sell its balance sheet someday, then are there no inflationary consequences?

    If true, then what matters the national debt?

  18. Gravatar of Scott H. Scott H.
    18. December 2017 at 17:44

    I guess the question comes down to: How much marginal growth is worth how much marginal deficit increase?

  19. Gravatar of ssumner ssumner
    18. December 2017 at 19:37

    Brent, Agreed, but my point is that the immediate post election bounce could have been due to other things, and if you look at 65 basis points over 12 months that’s not very much. You saw those sorts of fluctuations under Obama with no meaningful changes in trend growth.

    Kevin, You must be new here; I have 9 years worth of posts “owning” supply side economics.

    dtoh, Yeah, I have an open mind on the yield curve question; there are some unknowns about how to interpret it near the zero bound.

    Scott, If we have more deficits now then we must have an equal amount less at some point in the future. So it’s not clear we get ANY more growth in the very long run.

  20. Gravatar of dtoh dtoh
    18. December 2017 at 20:00

    I also think you have to question to what extent higher prices in other equity market are a result of expectations that there will be a significant spillover effect from expectations of higher US growth or a portfolio effect from investors moving from higher priced US equity assets to lower priced foreign assets.

    To me the real questions are…

    1. How much incremental cash flow is generated by the tax cuts.
    2. How much of the incremental cash flow goes to investment versus lower product prices/higher wages/increased distributions.
    3. How is the invested cash leveraged.

  21. Gravatar of foosion foosion
    19. December 2017 at 06:53

    One critique is that it’s not clear that GDP is the relevant measure of growth for US persons. It seems much of the growth reflected in many models is from foreign investment and foreigners expect a return on that investment, so GDP goes up more than GNP.

    BTW, Slate republished Krugman’s classic take on monetary economics http://www.slate.com/articles/business/the_dismal_science/1998/08/babysitting_the_economy.html

  22. Gravatar of KevinA KevinA
    19. December 2017 at 09:20


    Surprisingly, I’m a long time reader. Your usage of the supply-sider term must have just struck me as unusual this time.

    “The $10,000 cap on state and local income and property tax deductions is by far the biggest blow for high-tax, high-cost-of-living, liberal big cities and their surroundings.”

    Wow, it looks like we back off eliminating SALT altogether and instead went for a CAP.

    The things republicans do right, they only do partially right.

  23. Gravatar of Bob Murphy Bob Murphy
    19. December 2017 at 10:55

    Hi Scott,

    I’m *not* accusing you of a contradiction, I’m just curious what your exact resolution would be, if someone asks, “Why do we need to take a wait-and-see approach to the effect of tax policy on the housing market, but not on the equity markets?”

    I mean, I get that houses are less liquid than stocks, but after even just one month, wouldn’t the impact be reflected in the latest house sales?

  24. Gravatar of Alex Fahrin Alex Fahrin
    19. December 2017 at 13:52

    Considering the tax bill is neither:
    1. Passed.
    2. Law.
    3. Enforced until 2018.

    I’d assume the total housing purchases wouldn’t be affected much by it. Maybe we will see an effect later in 2018.


    Deficits do matter. Unless you believe Greece could have kept spending more and more? Why not tax 0 and spend 10000000? Why not just spend until GDP hits infinity and we are all rich?
    Because demand needs supply.

  25. Gravatar of ssumner ssumner
    19. December 2017 at 21:25

    dtoh, Yes, there could be some spillover, but you’d expect it to be considerably smaller.

    I still say that a 10 year bond yield of 2.45% does not presage rapid growth, but we will see.

    Bob, Good question, and I did think about that possibility. I decided to argue for a wait and see here partly because I didn’t think other people would find an immediate judgment to be plausible. I wanted to take a conservative stance on this question, to avoid getting sidetracked on an EMH debate. Many people would point out that house prices tend to respond more slowly to news that equity prices. Perhaps because of the very high transactions costs in the housing market, it just doesn’t seem to be as efficient as the equity market.

    I recently saw a very upbeat survey of housing developers, and this I’m inclined to think that the mortgage deduction changes won’t have much effect. If it was going to have a big effect, I think we’d already be seeing some signs. But I’ll watch the 2018 housing market with great interest. I don’t have an ax to grind on this issue.

    Does anyone know if the stock prices of home builders fell on news of the tax bill’s specifics?

  26. Gravatar of Alec Fahrin Alec Fahrin
    19. December 2017 at 22:34


    This video at least seems relevant. I might wait till tomorrow though.

  27. Gravatar of Benjamin Cole Benjamin Cole
    20. December 2017 at 03:32


    Of course, you are right, when an extreme example is used.

    But what about Japan?

    If the US adds $1 trillion more than otherwise to the $20 trillion national debt in the next 10 years, will anything change?

    What if the Fed buys back, say, $4 trillion of the national debt in the next 10 years. Then what?

    What if the US runs 4% annual inflation and 3% real growth in the next 10 years? What then matters another $1 trillion in nominal national debt?

    I suspect only a office-bound PhD in economics could really think the national debt matters, within certain very broad parameters. Big loosy-goosy topic.

    Greece’s mistake was losing control of their own currency. And yeah, they should have run a more balanced budget (and had a First World tax collection system).

    What Europe has done to Greece (and yes Greek leadership) would be a tragi-comedy except for the real-world ramifications for Greeks….

  28. Gravatar of Becky Hargrove Becky Hargrove
    20. December 2017 at 06:36


    You said, “I suspect only a office-bound PHD in economics could really think the national debt matters, within certain very broad parameters.”

    The national debt also matters very much to non economists such as myself, although I am not a liquidationist because I believe the supply side has great capacity to overcome its preference for wealth capture. Yes, present day debt structure has been extremely useful for overall prosperity. But too many prefer wealth capture instead of wealth creation, in part because capture means being able to get things done via authoritative means.


  29. Gravatar of B Cole B Cole
    20. December 2017 at 16:19

    Becky– I read and enjoyed your post. Not sure how it addresses my contention that a couple trillion more of national debt hardly matters in the ten years, given that we could run higher inflation, higher real growth or the Fed could simply buy back the debt.

    But hey I prefer helicopter drops.

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