Mike Smitka / Dec 23, 2017
Edited from a post on his Econ 102 course web site
Food for thought. The new tax bill will add $1 trillion in additional debt over the next decade – I emphasize that because the US already is adding debt faster than the economy is growing. The same is true of Japan. (Europe varies, but the OECD provides data that should allow an estimate of the growth rate of aggregate Euro Zone debt. I've not looked at their web site.)
As I will discuss in class during the Winter 2018 term, debt can't grow faster than the economy forever. The analysis is straightforward, though I won't do the arithmetic here. The stock of debt affects dynamics: the higher the level of debt, the more that higher interest rates make matters worse. So we've been helped since 2010 by exceptionally low interest rates. That is changing, with the Fed likely to bump short-term rates from 1.25% to 2.25% or higher in 2018. I expect rates to continue moving higher in 2019, once the new tax cuts phase in. For better or (in this case) worse, the Republicans in Congress are not conservatives, they're radicals who give only lip service to fiscal responsibility. At some point taxes must increase – again, debt can't grow faster than the economy indefinitely, and the deficit dwarfs the actual budget so even draconian cuts won't do the trick. (See the bottom graph, which uses Congressional Budget Office "cyclically adjusted" deficit estimates.)
Who on the political horizon is equal to the unpopular but necessary task of raising taxes? Japan's case does not make me optimistic. The issue is worse there, because debt is much higher, and thanks to demographics the economy is growing more slowly. Fiscal conservatives at the Ministry of Finance and elsewhere began talking about this issue in earnest in the early 1980s. Over time the need to cut deficits became sufficiently accepted across the political spectrum to be turned into legislation. The resulting shohizei (消費税, national consumption tax) took effect in 1989 with a modest 3% rate, as part of a broader tax reform that lowered other rates. The first big boost, to 5%, took effect April 1, 1997. The magnitude and timing of the increase was ill-judged, and the hike's initial impact was amplified by "buy now" campaigns for big-ticket items. Car sales boomed through late March 1997. Sales then fell off the cliff – I was living in Japan and visited a car dealership towards the end of the March. It was empty, because the registration process meant any sale wouldn't be recorded until after April 1. The consequent recession was such that, while the ruling Liberal Democratic Party continued to talk of further rate increases, it took 17 years to implement the next hike. There was always a good reason – the 9/11 US terrorist attack of 2001, the Lehman Shock of 2008, the 3/11 Tohoku earthquake in 2011, and pending elections all seemed to conspire to overcome good intentions. Meanwhile, and as expected due the to the rise of expenditures to cope with the aging of the population and various short-term stimulus and reconstruction projects, deficits remained stubbornly high. And that's in a country where the political consensus has remained one that taxes are too low, not that they are too high.
