Trump’s Economic Policy Proposals Back to the Future?

Bob Murphy Department of Economics

Boston College

A Panel With: George Alogoskoufis (Tufts and Athens School of Economics)

James Anderson (Boston College)

Robert Murphy (Boston College)

Moderated by Fabio Schiantarelli (Boston College)

Thursday, November 17, 2016

5:15-6:30PM

WalshHall,Room131

The Economic Consequences of Mr.

Trump

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Macroeconomic Impact of Trump Policy Proposals, 10 Year Horizon Real GDP Growth Employment Increase CBO Baseline 2.0% per year 7 million With Trump Policies: Trump Economist 3.5% to 4.0% per year 25 million Tax Foundation 2.7% to 2.8% per year Tax Policy Center 1.8% to 2.2% per year

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Sources: Bureau of Economic Analysis, CBO August 2016 Baseline, CRFB calculations.

Importantly, both those time periods benefited from more favorable demographics, with the baby boomersentering the workforce and reaching their most productive work years. By comparison, today the babyboomers are entering retirement, which will slow the growth of the labor force and suggests future growth islikely to be about a percentage point lower than it has been historically.

With a much slower growing labor force, the way to achieve 3.5 percent annual growth would be to increaseprojected productivity growth by nearly 150%, from 1.1 percent to about 2.6 percent per year. This level ofproductivity growth has not been sustained over any decade in modern history.

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Sources: CBO August 2016 Baseline, CRFB calculations.

To be sure, smart tax, regulatory, and energy reforms can help to boost growth. But most(http://www.taxpolicycenter.org/publications/effects-income-tax-changes-economic-growth) studies estimate(https://www.cbo.gov/publication/17507?index=6908) the impact to be relatively limited(http://crfb.org/blogs/do-tax-cuts-pay-themselves) compared to the boost Trump expects to see. Andimportantly, policies which increase the debt (http://www.crfb.org/papers/promises-and-price-tags-fiscal-guide-2016-election) are actually likely to slow economic growth (http://crfb.org/blogs/high-debt-drags-down-economy-0) over the longer term.

The bottom line is that regardless of who is president, the economy is unlikely to grow by 3.5 or 4 percentannually for any extended period of time. It is useful to aspire to these high levels of growth: pro-growthreforms can reduce deficits, increase wages, and most importantly improve people's lives. But counting onthis growth in order to keep debt from rising even faster than its current unsustainable path(http://crfb.org/papers/report-analysis-cbos-august-2016-budget-and-economic-outlook) would be a costlymistake.

Trump Would Take Two-Thirds of the Budget Off the Table

Assuming economic growth doesn't materialize, Trump's new tax plan is now in theory small enough to bepaid for with very aggressive reductions in spending (http://crfb.org/blogs/chairman-price-rolls-out-fy-2017-house-budget).

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Trump Job Calculation Uses a Rule of Thumb: Every extra 1 percentage point of annual GDP growth = 1.2 million jobs So (3.5% - 2.0%)*(1.2 million)*(10 years) = 18 million extra jobs above a baseline • Implies an Okun’s Law much more generous than standard textbook versions

• From supply side, if the extra growth was due to productivity gains, then would

have no employment effect If we assume growth reaches 3.5% and if we ignore these two points, is the 18 million job number feasible from a labor market perspective?

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Recently Asked Questions

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tion, continued declines in the participation rates of people with low skills, and incentives in the Af-fordable Care Act that discourage participation. Using Trump’s rule of thumb described above, we computed the annual differences between Trump’s promised 3.5% GDP growth and GDP growth in the CBO forecast, then applied to that difference an extra 1.2 million jobs per percentage point of dif-ferential GDP growth to obtain a path of employ-ment consistent with Trump’s claim of an addition-al 18 million jobs. Then, assuming the same unem-ployment rate and working age population as in the CBO forecast, we computed the labor force and participation rate required to accommodate the extra employment. The result is shown in the near-by chart, which depicts the history of the participa-tion rate and two separate projections. The lower of the two projections is the CBO’s. The higher of the two projections is the participation rate con-sistent with the CBO projections of population and the unemployment rate but assuming an increase in employment of 25.7 million over the next dec-ade instead of the 7.7 million in the CBO forecast. Trump’s numbers suggest that, instead of falling as in the CBO projection, the participation rate will quickly reverse course and push up to 67%, the highest rate on record.1 We do believe that, all else equal, lower marginal tax rates encourage an increase in labor supply. However, because Trump’s tax plan lowers average as well as marginal tax rates— that is, it is not “revenue neutral”— any positive “substitution ef-fect” on labor supply from lower tax rates would be at least partly offset by an “income effect.” Fur-thermore, our reading of the literature is that the

response of labor supply to changes in marginal tax rates is predominantly among secondary and lower income workers that constitute only a por-tion of the (potential) labor force, and that their response is relatively modest. In short, we consider the rise in the participation rate implied by Trump’s figures as simply not credible.2

55

60

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1948 1958 1968 1978 1988 1998 2008 2018Source: Macroeconomic Advisers, LLC; CBO; BLS

Labor Force Participation Rate Percent

HISTORY / CBO

TRUMP

2 Of course the labor force increases through additional immigration, but Trump’s proposed policies are intend-ed to reduce the flow of immigrants entering the coun-try. We will publish a piece on this shortly.

1 For data underlying this chart, contact Prakken@macroadvisers.com.

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Ten-Year Change in Fiscal Components by Candidate (Trillions of Dollars)

Source: Committee for a Responsible Federal Budget

How Would Clinton’s and Trump’s Policies Impact the Debt? Based on our preliminary update of our central estimates, both Clinton and Trump would

increase the debt relative to current law – though Trump would increase it by an order of

magnitude more, and Clinton’s plan would slightly reduce deficits if we incorporated unspecified revenue from business tax reform. Specifically, we estimate Clinton’s plans would add $200

billion to the debt over the next decade, while Trump’s plans would add $5.3 trillion.

Details of both candidates’ plans can be found in our June report Promises and Prices Tags, with

updates since June available in the next section of this report.

Fig. 2: Ten-Year Change in Fiscal Metrics by Candidate (Trillions of Dollars)

Note: estimates rounded to the nearest $50 billion.

Clinton’s plan would increase both spending and revenue. Under our preliminary updated

central estimate, she would increase primary spending by $1.65 trillion over the next decade,

including about $500 billion of spending on college education, $300 billion each on paid family

leave and infrastructure, and significant new health-related spending. Meanwhile, she would

increase revenue by $1.5 trillion on net, including $1.05 trillion from increased income taxes on

high earners and $150 billion of net business tax increases. Some of these tax changes were added

to her plan just this week. Clinton’s plan would also result in roughly $50 billion of additional

interest costs over a decade.

Meanwhile, Trump’s plan would decrease both non-interest spending and revenue. Under our

preliminary updated central estimate, he would lose about $5.8 trillion of revenue, including

$1.45 trillion from individual tax reform, $2.85 trillion from business tax reform, and $1.2 trillion

from repealing the taxes imposed by the Affordable Care Act (“Obamacare”).

$1.50 $1.65

$0.05

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-$5.80

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$3TRevenue Primary Spending Interest Surplus/Deficit (-)

ClintonTrump

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Debt Under Candidates’ Proposals (Percent of GDP)

Source: Committee for a Responsible Federal Budget

CHAIRMEN

MITCH DANIELS

LEON PANETTA

TIM PENNY

PRESIDENT

MAYA MACGUINEAS

DIRECTORS

BARRY ANDERSON

ERSKINE BOWLES

CHARLES BOWSHER

KENT CONRAD

DAN CRIPPEN

VIC FAZIO

WILLIS GRADISON

WILLIAM HOAGLAND

JIM JONES

LOU KERR

JIM KOLBE

DAVE MCCURDY

JAMES MCINTYRE, JR.

DAVID MINGE

JUNE O’NEILL

PAUL O’NEILL

MARNE OBERNAUER, JR.

BOB PACKWOOD

RUDOLPH PENNER

PETER PETERSON

ROBERT REISCHAUER

ALICE RIVLIN

CHARLES ROBB

ALAN K. SIMPSON

JOHN SPRATT

CHARLIE STENHOLM

GENE STEUERLE

DAVID STOCKMAN

JOHN TANNER

TOM TAUKE

PAUL VOLCKER

CAROL COX WAIT

DAVID M. WALKER

JOSEPH WRIGHT, JR.

Promises and Price Tags: A Preliminary Update

September 22, 2016

The next president will enter office with the national debt at post-World War II

record high levels. Debt held by the public currently totals over $14 trillion – nearly

77 percent of Gross Domestic Product (GDP) – and is projected to grow as a share of

the economy to almost 86 percent by 2026 and about 150 percent by 2050. This large

and growing national debt threatens to slow economic growth and is ultimately

unsustainable. Yet neither presidential candidate has a plan to address it.

In June 2016, we released Promises and Price Tags: A Fiscal Guide to the 2016 Election,

which estimated the budgetary impact of the policies put forward by the two major

party presidential candidates – Hillary Clinton and Donald Trump. Since then, the

candidates have released several new or adjusted policies.

Incorporating rough and preliminary estimates of these new policies, we find that

Clinton’s plans would increase the debt by $200 billion over a decade above current

law levels (compared to our prior estimate of $250 billion), and Trump’s plans would

increase the debt by $5.3 trillion (compared to our prior estimate of $11.5 trillion). As

a result, debt would rise to above 86 percent of GDP under Clinton and 105 percent

under Trump.

Fig. 1: Debt Under Central Estimate of Candidates’ Proposals (Percent of GDP)

These numbers are rough, rounded, preliminary, and based only on our central

estimates (instead of the broader range we originally provided). They also exclude

any economic impact and are based on our best understanding of the candidates’ policies as of September 21, 2016. We will continue to update these estimates as the

campaign moves forward.

60%

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2010 2012 2014 2016 2018 2020 2022 2024 2026

Current LawTrump, UpdatedTrump, June 2016Clinton, UpdatedClinton, June 2016

105%

86%

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Spending Cuts Needed Without Exempting Any Areas of the Budget

How Much Would They Need to Cut Spending? Achieving fiscal sustainability through spending cuts1 alone would require ambitious cuts for either candidate, and the cuts would be particularly sharp for Trump. Clinton would need to decrease total spending by 5 percent to stabilize debt as a share of the economy (or 7 percent if she also repeals the sequester as she has said she would do), and Trump would need to cut total spending by 15 percent. To balance the budget, Clinton would need to cut total spending by 14 percent (16 percent with sequester repeal), while Trump would need to cut total spending by 25 percent. Fig. 1: Spending Cuts Needed Without Exempting Any Areas of the Budget

Source: CRFB calculations based on CBO projections and each candidate’s official website. Yet both candidates have stated they wouldn't reduce Social Security – the largest federal program – and have called for net increases to the second largest program, defense. Both have platforms or statements that also imply they would be hesitant to cut Medicare. Just exempting Social Security, Clinton would need to cut spending by 7 to 20 percent (reflecting stabilizing the debt to balancing the budget) and Trump by 22 to 35 percent. If Social Security, Medicare, and defense were all exempted, Clinton and Trump would need to cut remaining spending by 13 percent (17 percent with sequester repeal) and 44 percent, respectively, to stabilize the debt. To balance the budget, Clinton would need to cut other spending by 36 percent (39 percent with sequester repeal), and Trump would need to cut it by 72 percent.

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Clinton Trump Clinton Trump Clinton Trump

Pay for Proposals Stabilize the Debt Balance the Budget

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Spending Cuts Needed if Exempting Social Security, Medicare, and Defense

Fig. 2: Spending Cuts Needed if Exempting Social Security, Medicare, and Defense

Source: CRFB calculations based on CBO projections and each candidate’s official website. The full range of cuts required to meet fiscal sustainability goals with different exemptions are in the Appendix table at the end of the paper. How Much Would They Need to Increase Taxes? Instead of cutting spending, Clinton and Trump could choose to raise tax revenues to slow the growth of the debt. In total, Clinton has already proposed an additional $1.5 trillion of net revenue increases over a decade, while Trump's plans would lose $5.8 trillion in net revenue. If the nominees were to stabilize the debt through tax increases alone, Clinton would need an across-the-board2 income tax hike of 3 percentage points (4 points with sequester repeal) above her proposed tax increases, and Trump would need a hike of 9 percentage points relative to his cuts. However, both candidates have also said they would not increase taxes on the middle class. Specifically, Clinton would not increase taxes on anyone making less than $250,000 per year, and Trump wants to lower taxes on the middle class generally. If Clinton were to achieve fiscal sustainability through income tax rate increases on high earners alone, stabilizing the debt would require a 17 percentage point increase (22 points with sequester repeal) above her current proposed tax increases, pushing the top tax rate – currently 39.6 percent or 43.6 percent under her current proposals – to 61 percent. Accounting for other taxes, this would be around and perhaps even above what most economists believe to be the revenue-maximizing

1%

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44% 36%

72%

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Clinton Trump Clinton Trump Clinton Trump

Pay for Proposals Stabilize the Debt Balance the Budget

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10-Year Revenue Loss from Trump Tax Plan: Static Dynamic Tax Foundation $4.4 to 5.9 Trillion $2.6 to 3.9 Trillion

Source: Navarro and Ross (September 29, 2016)

3

Table One: Tax Revenue Offset Under Trump Trade, Regulatory andEnergyPolicyReforms

Cumulative Federal Tax Revenue Increases

(2017-2026, Nominal Dollars, Trillions)

Trade Policy Reforms $1.740

Regulatory Policy Reforms $0.487

Energy Policy Reforms $0.147

Total $2.374

At $1.74 trillion, trade policy reforms provide the largest revenue gain. This is followed by regulatory reforms at $487 billion and energy policy reforms at $147 billion. This total positive revenue offset of $2.374 trillion dollars approaches the $2.6 trillion of tax reductions calculated by the Tax Foundation.4 With proposed spending cuts, the overall Trump economic plan is revenue neutral.

In the remainder of this report, we explain in detail each of these calculations. Our approach is fully transparent. To facilitate third party analysis, we provide the assumptions and calculations in appendices.

II.ThereIsNothingNormalAboutThe“NewNormal”From 1947 to 2001, the nominal US gross domestic product (GDP) grew at an annual, rate of 3.5% a year.5 However, from 2002 to today, that average has fallen to 1.9%.6 This loss of 1.6% real GDP growth points annually represents a 45% reduction of the US growth rate from its historic, pre-2002 norm.

Just why did the US growth rate fall so dramatically? Many left-of-center economists – and the Obama Administration – have described this era of slower growth as the “new normal.” They blame this plunge at least in part on demographic shifts such as a declining labor force participation rate and the movement of “baby boomers” into retirement. This view of America’s economic malaise is incomplete – and unnecessarily defeatist. It ignores the significant roles higher taxes and increased regulation have played in inhibiting US economic growth since the turn of the 21st century as well as our ability to fix the problems. This new normal argument also ignores the self-inflicted negative impacts from poorly negotiated trade deals and the failure to enforce them. One need look no further than the lengthy list of transgressions detailed in the National Trade Estimate for examples. These bad deals include most notably NAFTA, China’s entry into the World Trade

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Real Economic Growth Rate Needed (Annual Average Real GDP Growth)

Source: CRFB calculations based on dynamic feedback projections from Tax Foundation for revenue and CBO for immigration reform and ACA repeal. *Requires additional growth of less than 0.1 percent. **Assumes growth sufficient to maintain currently law debt-to-GDP ratio of 86 percent by 2026, although nominal debt levels will still increase.

For Clinton, balancing the budget through growth alone would require 4.5 percent growth (4.7 percent with sequester repeal) – a sustained rate more than double projected levels and not seen in over four decades. Even with a higher population from immigration reform, 4.5 percent growth would require levels of sustained productivity growth never seen in modern history. Under Trump's plan, growth would need to reach a sustained 6.1 percent annually – triple what most forecasters project. That's more than a full percentage point over the modern growth record (4.9 percent between 1958 and 1967) and would require productivity growth more than double what was achieved during that period. In other words, no achievable level of economic growth alone can put the debt on a sustainable path in concert with either candidate's current fiscal plans, particularly under Trump’s plans. Fig. 4: Real Economic Growth Rate Needed (Annual Average Real GDP Growth)

Source: CRFB calculations based on dynamic feedback projections from Tax Foundation for revenue and CBO for immigration reform and ACA repeal. *Requires additional growth of less than 0.1 percent **We assumed growth sufficient to maintain currently law debt-to-GDP ratio of 86 percent by 2026, although nominal debt levels will still increase. Time to Get Serious While Clinton has put forth a serious effort to pay for her proposals, neither candidate would address the unsustainable trajectory of our nation's debt – and Trump would substantially worsen it. Now more than ever, both candidates must tell us how they would confront our growing debt burden. It will take a mixture of spending cuts, tax increases, and entitlement reforms to produce the kind of growth and fiscal restraint necessary to put our debt on a sustainable path.

2.0%*

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Clinton Trump Clinton Trump Clinton Trump

Pay for Proposals** Stabilize the Debt Balance the Budget

Current Projected Growth: 2.0%

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Unfortunately, Donald Trump appears to have taken most of available reductions off the table by saying in arecent campaign fact sheet (https://www.donaldjtrump.com/press-releases/fact-sheet-donald-j.-trumps-new-child-care-plan) that remaining costs (emphasis added) "will be offset by minor changes in the currenttrajectory of spending for federal agency operations, excluding Defense, Veterans, Social Security andMedicare." Although this may only apply to the new tax offsets (not his entire agenda), it is consistent withhis previous statements that he would not reduce Social Security or Medicare (beyond a tiny amount of fraud(http://crfb.org/blogs/reducing-fraud-would-make-social-security-solvent)), and increase spending on defense(http://crfb.org/blogs/how-much-would-trumps-new-defense-plan-cost) and veterans(http://www.crfb.org/sites/default/files/CRFB_Promises_and_Price_Tags.pdf#32).

Although Trump has previously ruled out changes to Social Security and Medicare, this is the first time he'sbeen explicit on all of these categories. Of the current budget projections, the exempted categories make up64 percent of the budget.

Ruling out changes to two thirds of the budget makes it hard enough to pay for a multi-trillion tax plan, butthe plans Trump has put forward to date actually makes it even more difficult. For example, Trump has alsoproposed to increase defense spending by $450 billion over a decade (http://www.crfb.org/blogs/how-much-would-trumps-new-defense-plan-cost), expand veterans benefits (we estimate a $500 billion(http://www.crfb.org/sites/default/files/CRFB_Promises_and_Price_Tags.pdf#32) cost), and shrink other partsof the budget by repealing "Obamacare," trimming (http://www.crfb.org/blogs/how-much-would-trumps-new-defense-plan-cost) unauthorized spending and improper payments, and block granting Medicaid.

After taking his proposals into account, only 31 percent of the budget is available to finance his tax cuts (notethis excludes the effect of Trump's new Penny Plan, which we estimated would save $630 billion

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(http://crfb.org/blogs/explaining-donald-trumps-penny-plan-non-defense-spending) and is already being usedto pay for the tax plan).

It is possible that these exemptions apply only to the specifics of Trump's Penny Plan(http://crfb.org/blogs/explaining-donald-trumps-penny-plan-non-defense-spending) and not to areas thecampaign won't touch more broadly. But if they do apply more broadly, it could prove impossible for Trumpto pay for his tax plan, let alone reduce projected deficits.

***

During his campaign, Trump has vowed not to touch the two largest government programs, Social Securityand Medicare, which together are responsible for almost half of spending growth over the next decade. Hehas promised to increase spending in two more large categories, defense and veterans. These exemptions andexpansions make it difficult, if not impossible, to allow for the spending cuts needed to finance his tax cutsand put the debt back on a sustainable path. The level of economic growth that the campaign is relying on isan admirable goal but likely not possible to achieve in practice and shouldn't be relied upon.

For both of these reasons, the likelihood is very high that his proposals still add substantially to the debt. Inlight of this reality, we hope Donald Trump makes further improvements to his tax plans and reconsiders hisplans to exempt the largest federal programs from any change.

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Figure

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Source: Federal Reserve Board 2016