How to Engineer a Trump Boom
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With Republican efforts to replace ObamaCare in tatters, President Trump now says that he should have started with tax reform. Better late than never. With the right mix of policy to stimulate the economy, the Trump administration could realistically generate 3% to 4% growth in gross domestic product.
Any package proposed by Mr. Trump will probably cut corporate tax rates, reduce individual marginal rates, and broaden the tax base. This could be the biggest overhaul to the tax system since the Reagan reforms of 1986, which lowered households’ average marginal income-tax rates by 2 percentage points each in 1987 and 1988.
Since 1930, these types of tax-rate cuts have stimulated economic growth. If Mr. Trump lowers average marginal individual tax rates by 2 percentage points, I estimate that the boost to real growth in gross domestic product would be about 0.5% a year for the next two years. This does not factor in the stimulative effects from reduced corporate rates.
Reforming energy, environmental and financial regulations could also boost growth. Predicting the effects is difficult, but the World Bank’s rankings on the ease of doing business are a good place to start. The U.S. stood at third overall in 2006 but slipped to eighth in 2017. Empirical analysis across countries shows a substantial positive effect on economic growth from a more favorable business climate, as measured by the World Bank’s overall indicator. In research for an upcoming American Enterprise Institute paper, my colleagues and I have found that improving America’s business conditions to match those of the top performer (New Zealand in 2017, Singapore in 2012), would boost annual economic growth by about 0.3%.
Investing in infrastructure could help, too. The job-creating aspects of the construction phase of a building spree wouldn’t matter as much as the productivity effects—such as more-efficient transportation due to improved highways. An infrastructure program should focus narrowly on useful projects: roads, bridges, airports and maybe railroads. Avoid “bridges to nowhere” and building for its own sake, for which Japan has become famous over the past couple of decades. It’s difficult to quantify the growth effects from an infrastructure program, but given the poor state of America’s transportation networks, they are likely to be substantial.
Mr. Trump hopes some of his infrastructure program can be privately funded. But the rest could put significant strain on the federal budget, a consideration heightened by the already high ratio of U.S. public debt to GDP, about 78% for privately held federal debt. Acknowledging this fiscal reality, the 2010 Simpson-Bowles report touted entitlement reform, including raising the age of eligibility for Social Security. That’s important to get done. Raising the age for Medicare would also be a good idea. Thus far, however, the only entitlement reform that seems to interest the Trump administration is scaling back the Medicaid expansion under ObamaCare.
The president’s economic package may also include restrictions on trade and immigration. These are negatives for economic growth. In this context, a border-adjustment tax levied on imports and used to subsidize exports, as House Republicans have proposed, could be a good idea. Theory holds that such a tax would not have much effect on trade volumes, because the value of the dollar would rise to compensate. But the U.S. runs a substantial trade deficit, so the border-adjustment tax would raise around $100 billion a year in federal revenue. That would help restore the fiscal balance.
A different, perhaps cynical argument is that a border-adjustment tax would allow the president to claim to be protectionist (taxing imports as promised) while not really being so (because of the offsetting adjustments of exchange rates). A value-added tax, which is a levy on consumption, would be better according to economic theory. But the border-adjustment tax is still a good idea.
America’s economy has not recovered from the Great Recession. Real GDP has been growing at around 2% a year. This weak performance mostly reflects the lack of productivity growth since 2010. If Mr. Trump can raise annual productivity growth from zero to 2%, that alone would be a huge favor to the economy.
With reduced tax rates, regulatory reform, and infrastructure investment, economic growth could hit 3% to 4% a year for the next couple of years. It will all be wasted, however, if the U.S. ends up in a 1930-style trade war. With any luck, the coming focus on tax reform—and then on regulations and infrastructure—will lead the Trump administration away from the idea of adding impediments to international trade.
Mr. Barro is a professor of economics at Harvard and a visiting scholar at American Enterprise Institute.