A Growing Economy Requires Stable Policy. How do you know if we are in a recession? Most economists would say you won’t know—until you’re already in one.
The good news is that the United States is in the midst of the longest economic expansion in recorded history. A recession—two quarters of negative growth—does not seem to be in the cards, at least not immediately.
However, a growing economy needs people and businesses to invest in future products and innovations so that workers’ wages can continue to grow and jobs remain plentiful. Right now, lawmakers in Washington are creating so many unknowns about the future—casting uncertainty over everything from global trading relationships to future tax rates—that businesses are rethinking their plans.
Policy Uncertainty Threatens Economic Expansion
Consider a business choosing its next investment site. How big should the factory be? Will it be able to sell its new products internationally? What tax rate can it expect?
As the uncertainty around each of these questions increases, the business will invest less. Policy uncertainty causes new projects to be delayed and sometimes canceled. Those delayed projects represent lost jobs and outdated, more expensive, less efficient products.
There is no mathematical equation that mandates regular recessions; it is entirely possible for our strong economy to continue growing. If uncertainty about the future is ultimately overcome, it will be partly thanks to two positive reforms of economic policy: the 2017 tax cuts and ongoing reductions in red tape.
Two big policy changes made in 2017 are helping to support investment and in turn the current good economy. First, Congress cut and reformed taxes. Second, President Trump’s administration reoriented the government away from increasing regulatory burdens and toward removing a few of the most costly regulations from past administrations. Following these reforms, the Council for Economic Advisors showed measurable increases in investment, job openings, and economic confidence.
The 2017 Tax Cuts and Jobs Act was far more than a temporary stimulus, as its detractors often claim. Its reforms included lower marginal tax rates for individuals and families. These tax cuts allow people to spend and save more.
Even more important were the act’s corporate tax cuts: reforms that both lowered the income tax rate and allowed new investments to be deducted from income immediately (called “expensing”). These changes spurred—and continue to spur—new investments in America.
If made permanent, the tax cuts—paired with the administration’s work to slow the addition of new regulations and roll back the most punitive rules from past administrations—would represent a truly major structural reform for the American economy—one that promises to increase business investment and labor supply year after year.
Clearly, two years on, they are helping the economy. Consumer spending and confidence remain high. Businesses are still hiring: there are over 7 million job openings, and wage growth has averaged close to 3 percent over the last year according to the Bureau of Labor Statistics. Meanwhile, the lowest 10th percentile of wage earners (those making about $12 an hour) has experienced wage growth of 6.6 percent over the last year.
Growth Is Not Inevitable
When consumer confidence is strong and there are plenty of jobs, continued economic growth must come from greater supply of workers and investment. The economic headwinds now are buffeting the supply side, damping new investments.
High levels of policy uncertainty associated with domestic politics are depressing the expected gains from tax and regulatory reforms and could threaten to slow growth even more in the months to come.
The administration’s orientation toward trade has upended global supply chains, creating negative effects that ripple through the rest of the world economy. Threatened or imposed tariffs on American’s biggest trading partners, including the European Union, Japan, France, Canada, and Mexico, are precipitating the balkanization of had been increasingly connected global markets.
The costs for Americans buying and selling goods abroad has steadily increased in the last few years due to this administration’s trade policy. Additionally, uncertainty about future trade policy has delayed planned business activity and could ultimately lead to the cancelation of planned investments altogether.
Threatened tariffs on countries other than China and congressional inaction on the U.S.-Mexico-Canada Agreement only serve to weaken already fragile economies around the world. And there are many more unknowns—the fate of Brexit, a looming Italian debt crisis, consumption tax increases in Japan, and an economic slowdown in China— each presenting an economic challenge to reliable access to global markets.
It’s not just trade uncertainty. Unprecedented levels of U.S. government debt and uncertainty about the direction of domestic fiscal policy after the 2020 elections pose significant additional economic unknowns for businesses making investment plans.
Next year the federal government is expected to borrow at least $1 trillion to cover the gap between spending and tax revenues. And it could easily go much higher. The progressive left has proposed policies that would increase annual federal spending by almost $10 trillion.
If spending is increased substantially, taxes will have to rise to levels never seen in the United States—possibly eclipsing even many high-tax European countries.
Investors are forward-looking and know that a lot of voters want to raise revenue by taxing their businesses and investment returns. According to a Morning Consult poll, more than 60 percent of voters now favor a wealth tax—Sen. Elizabeth Warren’s favorite way to soak the rich.
Even if spending does not increase, without significant spending reductions, taxes will have to increase.
This uncertainty about future policy depresses economic conditions by pushing investors into safer assets—like government bonds instead of new businesses—which means firms postpone or forego new investments and hiring. Ultimately, high business taxes, wealth taxes, and capital gains taxes hurt workers, producing fewer job opportunities and slower wage growth. The serious prospect of future tax hikes can do the same.
Debt and Downturn
Uncontrolled deficits have also led to large debts, a poorly understood source of economic uncertainty. Sustained, high-levels of sovereign debt during peacetime is a relatively new phenomenon. Even so, there is mounting evidence that current levels of debt are already dragging down U.S. economic growth.
Policymakers will likely never be able to prevent a recession, but we can reform current policies so that they stop depressing economic activity.
But the size of future debts is likely an even greater source of economic risk than current debts. Assuming a relatively strong economy, U.S. debt is projected to exceed the nation’s total economic output (GDP) in 15 years.
An economic downturn will only widen the gulf between revenues and outlays as more people tap into existing benefit programs and tax revenues decline.
Congress can reverse much of the uncertainty around global trade and domestic fiscal policy. By simply setting out a stable policy agenda for trade and the federal budget, businesses and individuals could begin making plans again.
Policymakers will likely never be able to prevent a recession, but we can reform current policies so that they stop depressing economic activity. Working with the administration, Congress can unleash America’s growth potential by continuing to remove impediments to new investments and entrepreneurship.
Congress can bolster the administration’s regulatory reform efforts by repealing the costliest financial, environmental, and labor regulations. Removing the myriad impediments to doing business in America requires the tedious work of culling unproductive regulations that have built up over time. Congress should commit itself to this task.
At the leading edge of the longest expansion in America’s history, policymakers should double-down on what has been working and fix what is not. Congress needs to reassert its authority in setting tariffs and codify new free-trade agreements in order to quiet the current uncertainty associated with trade. The 2017 tax cuts must be made permanent, and deficits need to shrink through spending cuts to ensure taxes stay low.
For now, the American economy is doing just fine. It could do even better if Washington got out of the way.
A senior policy analyst in The Heritage Foundation’s Grover M. Hermann Center for the Federal Budget, Mr. Michel focuses on tax policy and the federal budget.
