Three Holes in the Trump Budget

Let’s talk about the Trump administration’s budget proposal, which the White House introduced last week (it's only a proposal—it is the role of Congress, not the White House, to pass the actual budget). I don’t want to focus on the substantive elements of the budget—whether the proposed spending allocations are good or bad as a policy matter. I'll leave that for another time.

Instead, I’d like to focus on (what should be) a non-partisan issue: the economic assumptions underlying the budget proposal and its projections. Specifically, the budget proposal contains three significant errors, each of which represents a larger problem with this administration.

First, the budget relies on revenues from the estate tax, which it plans to abolish.

The budget proposal clearly states that the estate tax (also called the "death" tax by opponents) will be abolished as part of the Trump administration’s tax reform. You can see it here:

The estate tax is a tax levied on estates with a value greater than $5.4 million (or $10.9 million for married couples), and is payable upon the death of the property owner. In other words, the tax is only paid by the very richest people in the United States (i.e., those inheriting very large estates). Only about 0.2% of the very wealthiest Americans pay the estate tax.

Shockingly, while the budget appears to abolish the estate tax on page 13 (as shown above), it also includes $328 billion dollars in projected revenues from the estate tax from 2018 until 2027! Talk about magic counting:

We can debate whether the estate tax should be abolished, but we should all be able to agree that the government cannot collect revenues from a tax that doesn't exist.

This is an error based on incompetence: not realizing that the administration is counting the revenues of a tax that it is planning to eliminate.

Second, the budget falsely claims that tax cuts will lead to an increase in revenues.

The idea that tax cuts can increase overall tax revenues, or can even be revenue-neutral, is nonsense. First proposed by economist Arthur Laffer in the 1970's, the theory states that cutting taxes generates economic growth, and that this growth can lead to an increase in government revenue even when we subtract the revenue lost from the tax cut.

This idea was first debunked in the 1980's, after the Reagan administration enacted a tax cut that significantly increased the federal deficit. We've recently seen a similar experiment play out in Kansas—taxes were heavily cut in an (unfounded) expectation of greater growth and increased government revenue. But the experiment failed miserably in Kansas, just as it has failed everywhere else it's been tried.

Most economists generally agree that only about one-third of revenues lost by cutting taxes end up being collected by the government as a result of faster economic growth. So if the goal is a balanced budget, the government would need to make up the other two-thirds of lost revenue by either reducing spending or implementing a separate tax increase.

But despite the overwhelming empirical evidence to the contrary, this administration seems to be insisting that its tax reform plan, based heavily on cuts, will not only be revenue-neutral but will also somehow reduce the deficit.

The budget proposal includes $2.1 trillion in overall revenues generated by the tax cuts, even after taking into account the revenue lost from the tax cuts. This shows that the administration doesn’t just believe in the fantasy that tax cuts will pay for themselves through increased revenues, but they’re also counting on these new revenues being much larger than the lost tax revenues. In other words, they’re double-counting 2 trillion dollars that probably shouldn’t even be counted once.

This is an error based on deceit: inserting fanciful figures into the budget, hoping the American people won’t realize that their government is manipulating them.

Third, the budget assumes a 3% growth rate, which is not realistic.

The budget relies upon the assumption that the economy will grow at a rate of 3% of GDP per year, even though no serious expert believes this is possible. The economy has been growing at an average of 2% per year since 2008. Virtually all economists believe that 3% growth is impossible in the near-term, even if a large tax cut is enacted, because the workforce isn’t growing as much as it once did and worker productivity isn’t increasing at sufficient rates. Even the non-partisan Congressional Budget Office projects economic growth at a rate of 1.9 percent for the indefinite future.

So why assume that we’ll see 3% growth, even though almost everyone, including many Congressional republicans, believe this is a fanciful projection?

This is an error based on wishful thinking: relying on wildly optimistic assumptions to market a proposal built on quicksand.

Conclusion.

We should debate the substantive components of the budget: where the government should spend money and what programs should be cut, which tax reforms are a good idea and which are not, how important is a balanced budget and what level of government debt is sustainable.

But economic assumptions and projections should not be politicized. They also shouldn’t be based on wishful thinking. When they are, everyone loses.