President Donald Trump has proposed a major tax cut and some simplification to the tax code — those are sorely needed but we shouldn’t expect too much.
The U.S. economy is experiencing what many observers in the 1980s called Eurosclerosis— sluggish growth and high unemployment instigated by high taxes that curb investment and an expansive welfare state that dampens incentives to train and relocate to find work.
The United States is not Europe in the 1980s or 1990s. We have a fair amount of investment in path-breaking technologies — consider the influence of Alphabet GOOG, +0.43% , Facebook FB, +1.38% , Twitter TWTR, +0.39% and Microsoft MSFT, +0.39% , the pharmaceutical and biotechnology sectors, and American innovations in petroleum extraction that have halved the global price of oil.
However, the low headline unemployment rate is deceiving. Labor-force participation by prime working age males is depressed in part because of pervasive access to Social Security disability, food stamps, Section 8 housing and Medicaid, and in two-income married households, the earned income tax credit.
Those combine to elevate effective marginal rates to levels that rival those imposed on high-income Americans by our profoundly progressive tax system.
But the slow growing effective supply of labor is only part of the problem.
Globalization has shut down factories in many small towns far from large urban centers. Competition from China is a problem but the lack of access to sophisticated technical training and economic barriers to providing high-speed internet in less-populated areas make new investment in these areas problematic.
More rigid zoning in big cities — liberals like those for environmental reasons and conservatives to preserve architectural character and limit population density — is pushing up rents and home prices making relocation by the unemployed to these areas too costly. Also, the explosion of state licensing requirements for many occupations limits mobility across state lines.
Traditional sources of aggregate demand have dried up too.
Effective U.S. corporate tax rates are much higher than in other industrialized countries, and the transition from manufacturing to technology to drive growth — save the oil and gas boom — permit businesses to create wealth with much less spending on new equipment and structures.
The above mentioned zoning laws and rising prices for land within commuting distance to urban job centers have reduced housing starts to about 60% of its prerecession levels.
It appears auto sales have reached a peak — it seems just about everyone who can afford one has replaced their prerecession sedan with a more-fuel efficient SUV — and for the next several years, auto and light truck sales will likely hover around 17.3 million units accomplished over the last 12 months.
The Trump tax plan is hardly perfect. Its size is constrained by the Treasury reaching the limits of borrowing capacity and adding a special personal rate for pass-through entities will increase, as opposed to reduce, the complexity of the tax code — the same goes for the preservation of several tax breaks, such as the mortgage-interest deduction and R&D tax credits.
With the top 25% earning 69% of the income but paying 87% of personal income taxes, most of the benefits of tax cuts will go to upper income and rich households.
Still the tax plan would instigate more spending and make the U.S. a somewhat more competitive location for investment.
Treasury Secretary Steven Mnuchin’s claim that his tax plan will pay for itself with the additional revenue by boosting annual growth to almost 3% makes this economist wonder what folks are smoking at Treasury these days.
However, between the Keynesian jolt and improved tax competitiveness the plan should add 2 or 3 tenths of a percentage point to growth.
These days, that isn’t bad!