OPINION:
Whoever captures the White House, the federal government faces daunting fiscal challenges and tough “guns and butter” trade-offs.
The Congressional Budget Office projects the federal deficit will grow from about 5.6% of gross domestic product this year to 6% in 2033. The public debt will increase from 99% of GDP to 114% and continue rising.
Those projections assume inflation and real GDP growth at 2%, interest rates falling significantly from current levels, and current laws remaining unchanged. Importantly, nondefense discretionary and defense spending would grow only at the pace of inflation.
Military spending would fall from 3% of GDP to 2.5% by the mid-2030s. But to defend Europe and fight a war in the Pacific, a 25% to 50% greater force capability would be required. That implies raising defense spending to well above 4% of GDP.
The 2017 Tax Cuts and Jobs Act simplified and cut individual income taxes and lowered business taxes; the combined average federal and state corporate rates at 26.5% is just about in line with the rates in Europe.
The Tax Cuts and Jobs Act, or TCJA, was passed under reconciliation rules, which required no negative budget impact beyond a 10-year window. Consequently, most of the individual income tax cuts expire at the end of 2025, while most of the corporate tax reductions continue.
If former President Donald Trump is reelected, the TCJA will likely be extended. President Biden, however, would prefer that benefits for families with annual incomes over $400,000 lapse and that taxes on business and corporate income be raised.
The latter is unlikely unless the Democrats win control of Congress, but the Senate electoral map is highly favorable to Republicans this year.
Extending the TCJA’s individual income tax cuts would cost at least $3.3 trillion through 2033 and increase the public debt to more than 114% of GDP by 2033.
Borrowing costs would rocket — a fiscal train wreck.
Last July, the Treasury announced a substantial increase in borrowing requirements to rebuild cash balances after the budget ceiling standoff in Congress. By late October, the 10-year Treasury rate had increased to nearly 5%.
Without permitting the personal tax provisions of the TCJA to expire, the debt will grow to at least 120% of GDP over the next five years. At that point, just the interest on the national debt would be 6% of GDP and grow faster than nominal GDP.
This would likely instigate a flight from Treasuries in international markets — effectively, a vote of no confidence in the dollar as the reserve currency and a rise in the prominence and influence of China’s yuan.
The death of king dollar!
Mr. Trump reportedly wants to cut the corporate tax rate from 21% to perhaps 15%. That would cost an added $250 billion through 2033.
He could maintain the TCJA’s individual income tax cuts and cut corporate taxes by increasing tariffs.
Through Mr. Trump’s actions against China and others, the average tariff on U.S. imports rose from about 1.4% in 2017 to 3.0% in 2021.
Encouraged by Mr. Biden’s efforts to diversify supply chains, businesses have shifted to non-Chinese sources, lowering the average rate again. But with a universal 10% tariff, escape options would be few.
U.S. merchandise imports exceed $3 trillion. Factoring in his proposed 60% tariff on goods from China, Mr. Trump could indeed extend the TCJA and cut corporate rates without affecting CBO deficit projections much, but only if defense spending were permitted to decline to 2.5% of GDP.
Added tariffs would be partially paid by foreign producers, but most would be borne by consumers. Relying on tariffs would be much more regressive than letting the TCJA personal tax provisions expire because poorer households spend larger shares of their incomes and save less than the wealthy.
Leaving the federal corporate tax at 21% would be desirable because we now have significant evidence that the TCJA encourages more business investment.
Many of the new investments in artificial intelligence — especially foundation models — are financed by retained earnings from Big Tech. Reducing that pool of capital threatens U.S. leadership and the funds needed to catch up with the U.S. industry in electric vehicles and batteries and build out a greener energy system.
To accommodate adequate defense spending and avoid substantial cuts in older adults’ benefits and the social safety net, Americans will have to embrace higher tariffs and personal and corporate income taxes or witness the end of the dollar as the world’s reserve currency.
The dollar’s status requires foreign central banks to hold U.S. Treasury securities and makes those quite attractive to multinational companies and individuals as a store of value and investment. Overall, the king dollar permits a large trade deficit and Americans to consume more than they produce.
Failure to address the nation’s precarious finances will erode that status and lower U.S. living standards, much like a new tax.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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