- The Tax Cuts and Jobs Act that took effect in 2018 gave the economy a short-term boost.
- Whether or not the economic momentum can be maintained remains unclear.
- The federal budget deficit may be growing due to a combination of government spending and insufficient tax revenue.
It has been just over a year since Congress passed the Tax Cuts and Jobs Act. With tax time upon us, it’s an opportune time to assess the law’s impact on economic growth and the federal budget deficit.
Raised economic expectations
Two months after the president signed the tax overhaul bill into law in December 2017, the White House Council of Economic Advisers stated that prior to the enactment of the tax cut, the forecast was for the U.S. economy to “grow by an overall average annual rate of 2.2 percent through 2028.1” The Council members went on to say that their revised forecast, which assumes full implementation of the Trump Administration’s agenda, is for “real gross domestic product to grow by 3 percent a year, on average, through 2028.1” Administration officials added that they expected that the bill would be revenue neutral over the longer term, meaning it would not result in a larger federal budget deficit.
One year later, as promised, the tax cut has had a positive impact on economic growth. Gross domestic product (GDP), a measure of the growth in the economy, accelerated in 2018 to 2.9 percent, up from 2.2 percent in 2017.2 Growth rates achieved in the second and third quarters were the fastest in five years. Corporate earnings certainly benefited, rising more than 20 percent in 2018,3 an estimated half of which is attributable to the tax cut. Business investment also rose to its highest level in six years.
How sustainable is this improvement?
In December 2018, administration economists forecast that growth would be sustained at 3 percent once again in 2019, but not everyone agrees. The Congressional Budget Office (CBO) forecasts growth of 2.3 percent this year. Both the Federal Reserve and the 60 economists surveyed by the Wall Street Journal anticipate growth of 2.1 percent.
As the short-term effects of the tax cut begin to recede in the fourth quarter of 2019, longer-term growth is expected to slow. The CBO projects growth of just 1.7 percent a year from 2020 to 2023, before rising to an average of 1.8 percent between 2024 and 2029. The Federal Reserve projects growth of 1.9 percent in 2020, 1.8 percent in 2021, and 1.9 percent over the longer term. The Journal’s survey anticipates growth of 1.7 percent in 2020 and 1.8 percent in 2021.
What about the impact on the budget?
A tax cut is considered revenue-neutral if it stimulates enough economic activity to generate sufficient tax revenue to overcome the impact of the tax cuts themselves. If not, the budget deficit grows, and the national debt grows along with it. In fiscal 2018, which ended Sept. 30, the tax cut was in effect for three calendar quarters, yet the federal budget deficit totaled $779 billion, or 3.9 percent of the nation’s GDP. That was an increase of $117 billion from 2017 when the deficit represented 3.5 percent of GDP. For calendar year 2018, when the tax cut was in effect for four consecutive quarters, tax revenues declined at a time when the new law was likely to have its greatest impact. The CBO projects that revenues will begin to rise in 2019. However, this may have less to do with economic stimulus and more to do with taxpayers creeping into higher tax brackets and baby boomers withdrawing savings from tax-deferred retirement accounts, thereby generating more taxes. Even that won’t be enough to prevent the deficit from rising, since spending is forecast to rise even faster.
Concerns about the future impact
Looking ahead, the CBO projects a fiscal 2019 deficit of $900 billion, or 4.2 percent of GDP, and for the 10 years from 2020 to 2029, it forecasts that deficits will average 4.4 percent of GDP, or a total of $11.6 trillion. By comparison, over the past 50 years, deficits averaged 2.9 percent of GDP.
To frame the challenge another way, national debt, not including programs such as Social Security and Medicare, will total 93 percent of GDP4 — the highest since World War II. In comparison, the country’s debt-to-GDP ratio before the 2008 financial crisis was only 38 percent.
Prepare for the future
In its first year, the tax cut passed in 2017 undoubtedly contributed to an acceleration of growth. However, some long-range forecasts suggest it will be difficult for the economy to sustain that level of growth and prevent the deficit from rising. Only time will determine the actual long-term impact.
As for the impact on your own finances, be sure to consult with your Ameriprise financial advisor and your tax advisor as you make your plans to secure your own financial future. Taxes are always a consideration as you make decisions about how to manage your money.