Given that Donald Trump supports all of its extensions and Kamala Harris supports most of them, the TCJA is likely to survive and most voters will maintain low tax rates. If so, it could be the last gasp of the free lunch era — the illusion that America can cut taxes and increase spending without paying any of the consequences.
But America’s fiscal realities are catching up with its political realities. Politicians will have to grapple with budget constraints again by the end of the next president’s term, if not sooner.
Since George H.W. Bush became president, raising taxes on all but the wealthiest Americans has been unthinkable. This may explain why most Americans’ tax rates have declined over the past few decades, even as the size of government has expanded.
This also helps explain why either candidate is highly unlikely to allow the TCJA to lapse. Harris has promised not to raise taxes on people making less than $400,000, indicating that she will maintain all provisions of the law that apply to those earners, who make up about 98% of the workforce. There is. President Trump plans to make all provisions of the TCJA permanent. Both candidates have promised tax cuts beyond those provided by the law, including expanding the earned income tax credit and child tax credit (Harris), eliminating taxes on overtime pay and Social Security benefits (Trump), or eliminating taxes on tips. (Messrs. Harris) are proposing. and Trump).
On the spending side, Harris wants to add new rights by having Medicare cover long-term care. She would raise not only the corporate tax rate but also some taxes on high-income earners, and perhaps tax the assets of high-income earners. Overall, Harris’ plan is considered more fiscally responsible — it would increase the primary deficit by just $2 trillion. Trump’s case would be an increase of $4.1 trillion, but those are all ridiculous numbers, and the fact that Harris’s numbers aren’t so ridiculous should give voters and the bond market much reassurance. isn’t it. Both parties suffer from their own delusions, with Republicans claiming that they can pay for themselves through tax cuts and higher tariffs, and Democrats claiming that all government growth can be financed by raising taxes on the wealthy.
The question is how long the market will continue to indulge in this illusion. The inflation of the early 2020s, caused in part by excessive stimulus spending, was a reminder of how reality can creep in. As the election approaches, another reminder could come in the form of higher term premiums. Interest rates may come down a bit after the election, but historically, large amounts of debt tend to push interest rates higher.
Of course, some will argue that it’s different this time, but the truth is that it’s been different for the past 20 years. Washington was able to keep spending because investors and foreign governments bought U.S. debt, no matter how expensive it became. That may be changing. Foreign demand for Treasuries has declined, both because other countries face their own economic challenges and because a decline in overall trade means less need for U.S. Treasuries. Buyers now tend to be investors looking for high-yield assets, suggesting that governments may not be able to sell debt and expect to provide such low interest rates for long. .
bloombergFaster growth could pay down debt. But it’s a big gamble, especially in a non-global, high-rate environment. Another constraint on policy is rising inflation, made more likely by an aging population and protectionist trade regimes. It is also possible that the recent effects of inflation have destabilized expectations and caused the term premium to rise. On the positive side, higher inflation will reduce debt, but what will the political cost be? Recent history suggests it will be great. I am.
The near-zero interest rate environment fostered the delusion of both taxpayers and politicians that laissez-faire fiscal policy was virtually costless. In a high-rate environment, that delusion becomes harder to maintain. CBO projects that interest payments will account for nearly 4% of GDP over the next decade, and eventually rise to more than 6%. This assumes that the 10-year bond interest rate will remain at about 4%. If interest rates rise to 5% or 6%, debt becomes an even bigger burden on your budget. At that level, simply rolling it over will cause interest rates to rise and begin crowding out private investment.
Next year’s debate over the Tax Cuts and Jobs Act may be the last one in which both sides compete to become more reckless. The United States is entering a higher interest rate environment as spending increases, unfunded entitlements are expiring, and debt demand is changing. That means everyone has to pay higher taxes, or else the government has to spend less.
My bet is on the former. Either way, it’s the end of an era. In fiscal and monetary policy, like the proliferation of corporate cafeterias, there is no such thing as a free lunch.
