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Numbers do not add up to a new round of tax cuts this year

Congress is unlikely to act on a proposal to make permanent the individual rate reductions in the 2017 tax law, and even if such a measure were to be enacted it might not spur additional economic growth, analysts and tax practitioners say.

The White House rolled out vague plans for a new tax package late last month. Marc Short, the White House director of legislative affairs, offered few specifics, aside from the provision on the individual cuts. Those reductions are set to expire in ten years.

"As you know, the corporate tax relief was permanent in this most recent bill, but because of procedural hurdles in the Senate, the individual rates were not," he said. "We'll have more to share with you guys later, but as far as the time frame, it's probably toward the end of the summer that will be unveiled."

But the political realities that required the Senate to pass the original tax law through a process known as reconciliation — allowing the bill to be passed without receiving 60 votes, as long as its provisions expire outside a 10-year budget window — have not changed, according to Shamik Trivedi, a senior manager in Grant Thornton's Washington national tax office.

"I don't know many people who are confident that a bill that addresses the individual rate cuts has a chance of passing in this Congress," he said, adding that the conversations surrounding a second tax cut appear to be mostly political messaging in advance of midterm elections in the fall.

Businesses do not appear to be betting on the passage of a second tax bill either, even if it could include technical corrections to clarify some of the law's provisions, according to Todd Simmens, BDO's national managing partner of tax risk management.

"Getting another landmark tax package like this so soon," he said, "I just don't think that's on the radar."

Economic blip

The passage of the 2017 tax law lowered the corporate income tax rate from 35% to 21% and shifted the U.S. international tax system to a territorial system, under which multinational corporations are taxed based on the location of their profits. Projections from the Congressional Budget Office indicate that real GDP is expected to grow by 3.3% in 2018 and 2.4% in 2019 while averaging out at 1.7% from 2020 through 2026.

"During the 2020–2026 period, a number of factors dampen economic growth: higher interest rates and prices, slower growth in federal outlays, and the expiration of reductions in personal income tax rates," the agency's April 2018 economic outlook reads. "After 2026, economic growth is projected to rise slightly, matching the growth rate of potential output by 2028."

Even if Republicans were able to make the individual rate cuts permanent, it would not necessarily trigger an increase in economic activity, according to Michael Brown, an economist with Wells Fargo Securities.

"People sort of adjust to having the additional income, and therefore the extension, just as we saw in the extension of the Bush tax cuts, really doesn't provide a tremendous amount of upside growth," he said.

But the timing of the extension plays an important role when it comes to macroeconomic effects, he added.

"It depends on what phase of the business cycle we're in when those are extended," Brown said. "With the Bush tax cuts, those were extended when the economy was on the downturn. We don't know what the counterfactual would have been … how bad things would have become on the consumer spending side had we not had some support from the tax cuts."

President George W. Bush signed tax cuts into law in 2001 that were set to expire at the end of 2010. President Barack Obama extended those cuts for an additional two years in an effort to avoid dramatic tax increases on households in the midst of the recession. Congress ultimately made some of those provisions permanent in the so-called 2013 "fiscal cliff" deal to reduce the deficit.

Growing debt pile

Extending or making permanent the individual rate cuts would have one significant consequence: pushing the U.S. deeper into debt. The tax cuts themselves were not revenue-neutral and required Republicans to use budget reconciliation to pass the $1.5 trillion cuts.

The Congressional Budget Office estimates that debt held by the public is set to reach 96.2% of GDP by the end of 2028, reaching highs not seen since just after World War II. If substantial tax increases and spending cuts do not materialize, the agency estimates the deficit would reach 7.1% of GDP by 2028 while averaging 6.3% of GDP from 2023 to 2028.

Passing large spending cuts could prove to be politically daunting for lawmakers since mandatory spending — which includes entitlement programs like Social Security and Medicare — has been viewed as largely untouchable and previous efforts to examine mandatory spending did not gain traction, said Michael Pearce, senior U.S. economist at Capital Economics.

Pearce said rising mandatory spending is realistically "the biggest long-term fiscal challenge faced by the U.S." According to the CBO, the U.S. government spent $2.5 trillion on mandatory items in 2017, with $1.6 trillion of that going to Social Security and Medicare.

Cuts to discretionary spending only partially address this concern, as the Congressional Budget Office predicted in its 2017 economic outlook that discretionary spending would drop from 6.3% of GDP in 2017 to 5.3 percent in 2027, "a smaller percentage relative to the size of the economy than in any year since 1962."

"The big problem that the tax plan has created is that it's reduced revenues," Pearce said. "Any solution would need to increase revenue as a share of GDP."

While Pearce said it isn't likely any major short-term consequences would materialize because of a potential tax extension, a larger fiscal deficit could increase the U.S. account deficit.

"A larger fiscal deficit, all else equal, will tend to push the current account deficit up," he said. "What you have then is a steady downward pressure on the dollar over a number of years."