The tax plan that the President touted at its official unveiling earlier this week has winners and losers. While the plan is thus far scant on details and revenue projections, it appears to be designed to win over Main Street and Wall Street. But, the biggest fight over it could come on K Street and getting any of this through Congress, especially by year-end as GOP leaders want.
Either way, the plan costs will far exceed the deficit budget. The Senate budget is expected to allow for $1.5 trillion in new deficits over the next decade, but according to estimates from the Center for a Responsible Federal Budget, the tax plan would add $2.2 trillion to the deficit in that time.
This brings the rising federal debt debate into play. Currently, publicly held federal debt stands at 77% of GDP and is expected to rise to 91% in a decade as baby boomers draw on social security and medicare. The tax plan with its $2.2 trillion in deficits would put federal debt over 100% of GDP.
The question is – Will the tax plan generate enough economic growth and activity to offset the impact of rising deficits?
Future Wealth’s View
In the short run, the economy and voters benefit from deficit spending as it drives economic growth. The tax plan will likely put more money in the hands of consumers who are likely to spend that money driving economic activity. At least, that’s the plan. But there is little evidence from the last few decades that a tax rate cut has raised underlying growth in the US meaningfully.
Over the long term, however, the negative consequences are far more pernicious. As the debt-to-GDP ratio increases, debt holders could demand larger interest payments for the added risk. Diminished demand for U.S. Treasuries would further increase interest rates and inflation which would eventually slow the economy. Ultimately, a debt crisis will mean an increase in tax rates to pay off the debt.
Financial markets will take notice and therein lies the long term risk to the average investor’s portfolio. And so, if the tax reform goes the way of healthcare reform in the next few months, we would not be shedding any tears.