Fiscal Policy Experiment: Success or Failure

The Trump Administration is cheering the initial GDP results for 2018, claiming that the fastest economic growth in more than a decade proves that the bold and risky fiscal policy experiment of legislating substantial cuts in business and individual taxes along with a significant increase in federal spending has been a success. Yet, it's too early to “ring the bell” of success as the GDP details show little positive influence from the tax cuts while the additional gain in nominal GDP was matched by a similar dollar increase in the budget deficit.

The idea behind the Administration's fiscal plan was very simple; reduce taxes to put more dollars in the hands of the private sector to spend and invest and combine that with an increase in federal spending to spur faster nominal GDP growth.

In 2018, nominal GDP growth of 5.4%, measured on the fourth-quarter to fourth-quarter basis, was the fastest annual growth since 2006, and nearly one full percentage point faster than the 4.5% gain in 2017. The near one percentage point acceleration in nominal growth resulted in $190 billion being added to level of nominal GDP in 2018, a dollar gain that matched the $193 billion increase in the 2018 calendar year federal deficit. Paying for faster nominal GDP growth by increasing the budget deficit by a like amount is not a successful long-term plan.

The GDP data for 2018 show mixed results from the tax cuts. For example, nominal consumer spending increased 4.6% in 2018 essentially unchanged from the 4.5% gain in 2017, showing little if any positive influence from the individual tax cuts.

The details on business investment were also disappointing. Despite the large reduction in business tax rates and more generous expensing rules for investment nominal spending on business equipment slowed to a gain of 6.1% last year, well below the 9.2% gain in 2017.

Spending on nonresidential structures did jump 9.4%, up from the 6.1% in the prior year, but almost all of the gain was centered in oil and gas drilling. Spending on manufacturing structures actually contracted 0.2% in 2018. The one bright spot in business investment spending was the 11.6% gain in intellectual property, the fastest gain in nearly 20 years.

The most direct and positive impact from the fiscal plan came from the increase in defense spending. In 2018, nominal defense spending increased 6.6%, an increase of 400 basis points from the prior year, and represented the largest annual increase in a decade. The growth impulses from faster defense spending will slow in 2019 and then stall or reverse depending on future budget authorizations.

A successful fiscal plan means at some point the economy reaches "escape velocity", or a growth rate that is self-sustaining and not dependent on an ever-widening budget deficit to support the pace of growth.

The consensus outlook for 2019 calls for real and nominal GDP growth of 2.3% and 4.5% respectively, the same rate of growth that was in place prior to the fiscal plan being enacted, while the federal budget deficit is estimated to climb almost $200 billion to nearly $1 trillion according to the Congressional Budget Office.

If at the end of the second year of the fiscal plan the rate of GDP growth is no better than it was before tax cuts and spending increases were enacted and the budget deficit is almost $400 billion larger it would be a mistake to call the fiscal plan a success. Thus, the critics of the fiscal plan may still have their day in the sun.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.