Abstract: On December 2, 2017, the largest tax bill in 30 years, actively campaigned by President Trump, was passed in the Senate with a minimum majority. The year-end of 2017 might see the disagreements between the Senate and the House settled and the tax reform bill will take effect in 2018. The Trump Administration attempting to stimulate the economic growth by tax cuts may worsen the federal government’s repayment sources in the short term. Meanwhile, the tax cuts, coupled with Federal Reserve’s rate rises, may cause greater debt financing and increase the government debt burden, thus threatening the government solvency.
1. President Trump attempts to boost the economic growth by tax reform and the broadening tax base thereon can hardly cover the costs of the tax cuts in the short term, thus leaving the government’s primary repayment sources to deteriorate.
The tax reform is expected to benefit the fiscal revenues in two ways: The direct effect is that lower tax rates will cut fiscal revenues. And the indirect effect is that in the long term, the country will generate more fiscal revenues because tax cuts will increase the tax base and strengthen the economy. At present, there is considerable uncertainty as to whether the bill will stimulate the economy. In the short term, costs of the tax cuts can barely be met, which will immediately undercut government fiscal revenues.
Firstly, there is considerable uncertainty as to whether the bill will stimulate the economy. The current sweeping tax reform generally follows the Reagan’s style and aims at promoting growth by boosting individual consumption and investment. However, the move is constrained by two factors: One is that the real economy is still seeing sluggish investment while Fed’s rate rises push up the financing costs and thereby undermine the positive effect of investment in the real economy. The other is that the tax reform in essence imposes greater tax burden on the middle class, the mainstay of consumption, and may thus undermine its contribution to growth. Therefore, it remains to be seen whether the tax bill will effectively bolster the economy and broaden the tax base in the short term.
Secondly, lowering the tax rates play a more direct role in reducing the government revenues. Tax revenues constitute a major source of the US fiscal revenues, of which income tax and corporate tax make up 47.3% and 9.2% in FY2016. Trump’s tax plan will reset the corporate tax rate at 20%. Disagreement still exists in the House and Senate over the tax brackets and the tax cuts for the rich. A conservative estimate suggests that the tax reform bill will annually cut the corporate taxes by USD 100 billion and reduce the income taxes by USD 50 billion. In the short term, the ratio of government fiscal revenues to GDP is projected to decline to around 17%, thus deteriorating government primary debt repayment sources.
2. The tax bill, combined with Fed’s rate rises, will widen the US fiscal deficit, worsen the structure of debt repayment sources and threaten its government solvency.
In the short term, the US government’s fiscal deficit will grow, thus deteriorating debt repayment sources. Firstly, confronted with the upcoming reductions in fiscal revenues, the Trump Administration is yet to come up with viable measures to cut fiscal spending. Therefore, it is forecasted that 2018 and 2019 will see the US government’s fiscal deficit rise to 4.0% and 3.9%. Secondly, Fed’s rate rises will incur higher debt refinancing costs in terms of the maturing debts during Trump’s first presidential term, thus increasing interest payments. Given the maturing debts in 2018 and 2019, it is expected that government debt financing needs for the same period will reach 20.4% and 17.6% of GDP, thus government sees increasing dependence on debts and mounting repayment pressure, as is shown in Figure 1.
A deteriorating debt repayment structure will pose a threat to the solvency of the US government. Failure to achieve a primary fiscal surplus will create an upward trend in the government debt burden. According to the estimate of Committee for a Responsible Federal Budget, the sweeping tax cuts will lead the national debts to expand by 10% in the following 10 years, reaching nearly USD 22 trillion, and by then the US government debt burden will exceed 120%. Dagong forecasts that 2018 and 2019 will see the US government debt burden rise to 110.4% and 111.2%. With its financial assets taken into account, the government’s net financial debt burden will continue to climb from an already high level of 77.5%, as is shown in Figure 2. Historically, the Reagan Administration’s tax cuts drove up the US government debt burden from 34.4% at the end of 1980 to 69.8% at the end of 1993, until it showed a progressive decline as a result of tax increases under the Clinton Administration in 1990s. However, at present, the crippling debt burden will allow only a limited scope for tax cuts for the Trump Administration. The US has a lack of support from its fundamental wealth creation capabilities. Its debt repayment structure, with debt financing and currency issuance as the main features, only serves to accumulate debt risks and threatens the US government solvency. (END)