After the tax cut in late 2017, the U.S. economy briefly grew faster than 3% before slipping back.
President Trump argues that he couldn’t possibly be guilty of anything because the economy is so great. Which makes me wonder: Whatever happened to his boast that the U.S. economy would be able to grow not only at 3% but at “4%, 5% or even 6%” per year?
Like so many of Trump’s promises, his hopes and dreams have collided head-on with reality. It turns out that making the American economy great again wasn’t nearly as easy as some politicians think.
GOP flying high
It seems like a million years ago, but in December 2017, when Trump signed the Tax Cut and Jobs Act (TCJA), the Republicans were flying high. With the tax cut, they had accomplished a significant legislative victory on their top priority issue. They celebrated that the economy would be able to soar once more.
And it did soar — a little bit, for a little while. Real gross domestic product (GDP) growth hit 3.5% in the spring of 2018, and it seemed for a moment to some Republicans that Trump might have been correct about the incredible impact that the tax cuts could have.
But then reality hit. Growth throttled back to 2.9% and then to 1.1%. Since the tax cut went into effect, growth has averaged 2.5%, about the same as the 2.6% recorded in the six quarters before the tax cut was passed.
Almost every forecast from professional economists, the Federal Reserve, the Congressional Budget Office, the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) — but not the White House! — looks for growth of around 2% per year for the foreseeable future. With the growth in the potential labor force slowing from about 1% per year to about 0.2%, it’ll take some very good productivity numbers just to hit 2%.
Ripples in the water
The consensus is that the tax cut changed almost nothing. It was like throwing a boulder into a lake: A big splash, some waves, but very little change in the water level once things settled down. Jason Furman, Barack Obama’s chief economist, says he and his co-author Robert Barro think the long-term impact of the tax cut will be to raise GDP by 0.04% per year.
That’s very little bang for a $1 trillion tax cut. It gets us one-hundredth of the way to 6% growth.
Despite evidence that the tax cut hasn’t been the game-changer it promised, the White House is sticking to its forecast of 3% growth for the next 10 years.
But what do others say?
The American Enterprise Institute, a conservative think tank in Washington, is hosting an online bipartisan symposium (#TCJANowWhat) on the impact of the tax cut, with blog posts and papers from economists, tax and fiscal policy experts, and various other wonks culminating in a face-to-face event on Oct. 22.
So far, about all the conservatives in the debate can say is: Don’t give up on the TCJA yet!
Incentive to invest
The tax cut was supposed to supercharge economic growth by giving businesses the incentive to invest in the equipment, R&D, software and physical structures that would boost their productivity. We particularly need much faster productivity growth now, because the other ingredient for a bigger GDP — labor-force growth — is in short supply.
But the tax cut didn’t have much lasting impact on business investment. In the six quarters since the tax cut passed, nonresidential fixed investment has increased at a 4.4% annual rate compared with a 4.7% pace in the six quarters prior to the tax cut.
Corporations returned most of their windfall to their shareholders, rather than putting it back into the business. And other data from the Census Bureau show that the tax cut had one other predictable consequence: The rich got richer.
Oil lubricates the economy
The trade war with China (and the rest of the world) isn’t the main cause of the growth slowdown. The consequences from tariffs and uncertainty could increase if tensions mount, but so far it’s only taken away a few tenths from GDP. The slowdown is mostly a reversion to the mean, and a reaction to lower oil prices, which have a surprisingly negative impact on U.S. investment.
In the second quarter, business investment declined at a 1% annual rate, according to revised figures from the Bureau of Economic Analysis released Thursday. That’s the first decline since early 2016, when low oil prices were hammering U.S. investment, especially in oil drilling.
The same thing is happening now. Investments in oil fields and other mining facilities have declined 7.7% in the past year as the price of oil CL.1, -0.51% fell from $70 to the mid-$50s. Those investments surged 14% in 2018 when prices were rising.
It seems that the price of oil was a bigger factor than the tax cut in the recent rise and fall in business investment.
According to Alexander Arnon of the Penn-Wharton Budget Model, the price of oil is now the key driver of business investment.
In his study, Arnon concluded that the rise in the price of oil from around $50 per barrel in late 2017 to $70 in late 2018 explains all of the growth in business investment in 2018, just as the drop in oil prices from over $100 in 2014 to near $30 in 2016 explained much of the decline in capital spending in those years.
All of this goes to show that making the economy great isn’t easy. Even a $1 trillion tax cut and massive deficit spending could only provide a temporary boost to the growth rate. The ability of any president to make large improvements in our living standards is exaggerated.
The ability of a president to make things worse, however, is really the more relevant story today.
Rex Nutting is a MarketWatch columnist.