Tax Cuts Clearly Boost Economy & Pay For Themselves

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 17, 2018

1. Tax Cuts Boost the Economy & Mostly Pay For Themselves

2. Out-of-Control Federal Spending is Still the Main Problem

3. Should We Finally Start to Worry About Higher Inflation?

4. Fed Meeting Minutes Don’t Suggest Even More Rate Hikes

Tax Cuts Boost the Economy & Mostly Pay For Themselves

The Congressional Budget Office (CBO) released its updated budget forecasts last week, and everyone focused on the projection that US budget deficits will top $1 trillion in 2020 and grow even larger in subsequent years. I wrote about that in detail in my Blog last Thursday.

What was largely lost in the latest CBO report was the fact that President Trump’s tax cuts are significantly boosting the US economy, much more than the CBO expected, and this added growth is largely paying for the tax cuts. I suggested this in recent months, but don’t expect the mainstream media to admit it anytime soon.

Last year before the tax cuts passed, the CBO projected GDP growth for 2018 would be just 2%. Now it figures growth will be 3.3% this year -- a significant upward revision. It also boosted its forecast for 2019 from a meager 1.5% to a respectable 2.4%.

This was unexpected by the CBO but not to those of us who understood that Trump's tax cuts and deregulatory efforts would boost economic growth. In any case, the CBO now expects GDP to be $6.1 trillion bigger by 2027 than it did before the tax cuts. That’s huge!

Earlier this year, the CBO estimated that the tax cuts Trump signed into law late last year would cut federal revenues by $1.69 trillion from 2018-2027. But the latest report now says that the higher rate of GDP growth over the same period will produce $1.1 trillion in new revenues.

In other words, at least 65% of the tax cuts will be paid for by extra economic growth. That’s a huge turnaround from what the mainstream media told us!

Tax cuts paying for themselves

Faster growth will also reduce federal entitlement spending tied to the economy — unemployment insurance, food stamps, welfare and the like — by $150 billion, the CBO says. If you subtract that from the cost of the tax cuts, the net cost drops to $440 billion.

So instead of losing $1.69 trillion in tax revenues over the next 10 years as earlier predicted, the CBO now says the cost will be one-fourth as much. They can’t get it much more wrong than that.

Out-of-Control Federal Spending is Still the Main Problem

While the good news is that the CBO has finally come to its senses regarding the economic benefits of tax cuts, there is still the problem of exploding budget deficits. The annual budget deficit is expected to top $1 trillion in 2020 and will remain above that level for the foreseeable future.

The good news is, with Trump's tax cuts in place, federal revenues climb every year as a share of GDP, going from 16.6% this year to 17.5% by 2025. (The post-World War II average for revenues is 17.2% of GDP.)

Here’s the problem. Unfortunately, spending is on track to climb even faster -- going from 20.6% of GDP this year to 23.6% by 2028. (The Post-War average is 19.3%.)

This is a disgrace and shows that Republicans love spending taxpayer money as much as Democrats. In fact, some GOP senators don't even want Trump to use his rescission authority to strip some of the worst spending items out of the recent bipartisan $1.3 trillion spending monstrosity.

Someone needs to remind these fake fiscal conservatives that if they can't get control of spending today, it's a virtual guarantee they'll have to agree to a "deficit-cutting" tax hike before long. I’ll get off my soapbox now and move on to other issues.

Should We Finally Start to Worry About Higher Inflation?

The Commerce Department’s Bureau of Labor Statistics (BLS) released the March Consumer Price Index number last week, and it was above pre-report expectations. The headline CPI rose 2.4% (annual rate) in March, up from 2.2% in February.

Core inflation, excluding volatile food and energy prices, rose to 2.1% from 1.8%, the largest 12-month increase since February 2017. Both CPI inflation measures are now above 2% for the first time since February of last year.

Consumer price index

It is important to note that the CPI increased in March partly due to the elimination of a sharp decline in the Index just over a year ago that was dropped from the latest calculation. This was widely expected, so perhaps it’s too early to get overly concerned about the CPI increase in March.

Despite that, the stock markets were spooked by the higher than expected CPI report and fears that the Fed might raise the Fed Funds rate three more times this year – instead of two more hikes that have been widely expected.

Keep in mind, however, that the Fed monitors inflation based on the Personal Consumption Expenditures Index (PCE) published by the US Bureau of Economic Analysis, which is somewhat different from the CPI. The PCE Index was up only 1.75% over the last year, and the core PCE (less food and energy) was up 1.6%.

Since the CPI and the PCE tend to move in the same direction, most analysts expect the PCE to top 2% before long, thus reaching the Fed’s long-held target for inflation. Once PCE inflation does reach 2%, the Fed will have to consider how high it will allow inflation to go and how long it will allow it to stay above 2%. More on this below.

Before we leave the discussion of the latest increase in the CPI, I thought it might be useful to show you the current makeup of the widely-followed inflation index. As you can see below, the largest components of the CPI are housing (by far), transportation, food and beverages and medical care.

CPI components

Fed Meeting Minutes Don’t Suggest Even More Rate Hikes

The latest Fed Open Market Committee (FOMC) meeting was held on March 20-21, and the detailed minutes from that meeting were released last week. Most Fed-watchers concluded that those minutes suggest three more Fed Funds rate hikes this year, rather than the two more the Fed has suggested previously.

Let’s take a look at what the March FOMC minutes actually said. The meeting began with a discussion of the increased stock market volatility and the decline in prices since the January meeting. From there, the discussion turned to the economy and inflation, as usual. The Committee concluded that the economy (GDP) continued to grow at a “moderate pace” and inflation remained “below 2%.” Nothing new there.

The Committee did discuss the fact that the labor market continues to strengthen but noted that labor compensation (wages) “remained modest.” Business spending, the Committee noted, appeared to be “moderating” in the 1Q after increasing at a solid pace in the 4Q. Ditto for government spending in the 1Q, which the Committee said was “flattening out.”

As was widely expected, the FOMC did vote to raise the Fed Funds rate by 25 basis points to 1.50%-1.75%, and there was discussion of additional rate hikes at subsequent meetings. However, the minutes clearly show that most FOMC members expect monetary policy to remain “accommodative” (ie – continued low interest rates) over the next few years.

Here are three quotes from the minutes:

“Members expected that economic conditions would evolve in a manner that would warrant further gradual increases in the federal funds rate.

Members agreed that the strengthening in the economic outlook in recent months increased the likelihood that a gradual upward trajectory of the federal funds rate would be appropriate.

Members continued to anticipate that the federal funds rate would likely remain, for some time, below levels that were expected to prevail in the longer run.”

The bottom line is that there was no specific talk of raising the Fed Funds rate three more times this year, as opposed to two more increases as has been telegraphed previously. While the Fed does see the economy improving this year, it does not currently see inflation as a serious problem.

While some analysts interpreted the March minutes as a signal that the Fed was becoming more hawkish, my reading of the minutes (boring as they are) did not result in such a conclusion. As such, I wouldn’t worry about it for now. Two more rate hikes this year, rather than three, seem to be the most likely course for now.

The next FOMC meeting will be May 1-2 but a rate hike is not expected at this meeting. The next rate hike is expected at the June 12-13 meeting when Fed Chairman Jay Powell will hold a news conference afterward. I’ll keep you posted.

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All the best,

Gary D. Halbert

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