We write to discuss why the recent Republican tax cuts are not likely to stimulate the long-term real economic growth under the prevailing conditions. Real economic growth means the economy is producing more stuff, that is, real (i.e., inflation-adjusted) gross domestic product (GDP) is increasing.
In order to produce more stuff, the economy needs more inputs, such as workers, raw materials and machines (capital), or an increase in how much stuff the average worker can make (economists call this productivity). Lowering taxes does not increase the number of workers or raw materials in the nation. Theoretically, lowering corporate taxes might give firms more money to buy more machines, but firms already have ample cash (more than $2 trillion overseas and $500 billion in the U.S.) and have not yet made any significant purchases of new capital. So, adding more money to the coffers of firms will probably not result in an increase in capital. Additionally, firms seem to have little interest in spending their excess cash on new technologies, which could improve workers’ productivity.
Simply put, when an economy is at full-employment, such as the U.S. economy, tax cuts only put upward pressure on prices and wages (the price of labor), leading not to real economic growth but inflation. The reasons are simple. Tax cuts do not create more workers. Tax cuts do not create more raw materials. Tax cuts do not create more capital. Tax cuts do not create more or better technology. All that the tax cuts will do is increase the federal government debt and create more inflation, especially if not accompanied by a properly targeted spending policy.
We know which government policies stimulate long-term real economic growth. One is increasing a particularly important type of capital, namely, human capital through investments in education in general and higher education and training in particular. The problem is there is a long gap between the investment and the payoff. Unfortunately, today almost every state and the federal government are reducing support for higher education, and technical (plumbing, electrical, carpentry, etc.) training in our high schools and community colleges is almost dead. Overall state funding for public two- and four-year colleges in 2017 was nearly $9 billion (more than 20 percent) below its 2008 level after adjusting for inflation. In addition, President Trump has proposed a 13.9 percent cut in the budget of the Department of Education. So, both state and federal governments are markedly decreasing their investments into human capital.
A faster method to increase human capital is to increase immigration, especially of those with above-average technical and scientific skills. However, the president and his supporters are adamantly anti-immigration, regardless of the immigrants’ technical and scientific skills. Under a new rule being considered by the administration, some 50,000 to 75,000 Indian H1B visa holders could be deported because the federal government has not yet issued their Green Cards. Last year, some 10,000 H1B visas were issued, a miniscule fraction of almost 85,000 issued every year prior to the Trump administration. Such measures actually drastically reduce, not increase, human capital in the U.S.
Yet another path to real economic growth is via basic research and development which leads to technological changes that increase worker productivity. However, in the Trump budget, funding for the National Institutes of Health is cut by 22 percent, NASA’s earth science research programs by nearly 9 percent, research at the Department of Energy by 15 percent and the National Science Foundation by 13 percent. The Department of Agriculture’s budget is cut by 11 percent.
During the Reagan administration, the notion a tax cut would pay for itself was disparagingly called “voodoo economics,” because tax cuts by themselves simply do not stimulate real economic growth. No matter how hard politicians try, they cannot change the natural laws of economics any more than they can the natural law of gravity. Under the current economic conditions, the recent tax cuts simply will not pay for themselves; they will most likely increase inflation. Worse, when combined with the budget cuts targeting research and development, they could result in another recession within the next decade.