President Trump has now sent a full budget message to Congress. This fleshes out the proposals published in March in the so-called ‘skinny budget’, which were pretty sketchy, and only covered funds that were appropriated rather than mandated.
A transforming ambition
The budget message, entitled A New Foundation for American Greatness, is ambitious. In his introduction, the President explains that its purpose is to ‘unleash the dreams of the American people’, to ‘drive an economic boom’, and to replace ‘economic stagnation with faster growth’. The document claims that total federal outlays are set to fall from 20.9 per cent of GDP in 2016 to 18.4 per cent in 2027. It forecasts that tax receipts are to rise from 17.8 percent in 2016 to 18.4 per cent in 2027, which would transform a deficit of 3.2 per cent of GDP into a very small budget surplus of 0.1 per cent (before rounding) in 2027. And it projects that federal government debt held by the public will fall from 77 per cent of GDP in 2016 to 52.2 per cent in 2027.
The proposed budget includes a significant reordering of spending priorities over the next ten years, including $800 billion of cuts to Medicaid. Part of that reduction in spending is to be a consequence of the replacement of the Affordable Care Act, but over and above those savings, a further $600 billion is to be removed from Medicaid, and $250 billion from the federal Children’s Health Insurance Program. There are also significant planned cuts to transfer payments over the next ten years. Measures to limit eligibility for food stamps will save $193 billion. Eligibility for the Earned Income Tax Credit and the Child Tax Credit will be limited, saving £40 billion, and disability benefits will be cut by $72 billion. Defence spending will rise by $200 billion, although it will fall as a share of national income from 3.2 per cent to 2.3 per cent of GDP. Meanwhile, non-defence discretionary spending will fall by 1.5 per cent of GDP.
Implausible economic assumptions
The economic assumptions used to construct the projected figures in the budget are optimistic and controversial. The administration is assuming that the long-term growth rate of the economy will be 3 per cent, which is much more optimistic than the Congressional Budget Office’s estimate of 1.9 percent, the Federal Reserve Board’s of 1.8 per cent, and the private sector Conference Board’s of 2 per cent. Under President Reagan, the economy grew by 3.1 per cent, stimulated by supply-side policies, which boosted growth as a result of cuts to high marginal income tax rates (70 per cent at the top), and regulatory reform. Now, there is clear scope to improve America’s supply performance by looking again at regulation, the structure and rate of corporation tax, and the Manhattan Skyline of marginal effective marginal income tax rates across the earnings distribution. But it is not clear that that would yield a plausible projection of economic growth of 3 per cent — and a budget based on dynamic scoring that relies on such a projection is very unwise. It also appears that some beneficial behavioural effects may have been double counted.
Reforming the federal civil service and containing its cost
Some of the administration’s proposals are sensible. For instance, an examination of the pay and conditions of the federal civil service is long over due: in a new study, the CBO estimates that federal employees receive pay and benefits averaging 17 per cent more than similar private sector employees. The proposals to limit eligibility to the EITC and student support are also sensible, but — from the sketchy information in the budget documents — appear timid.
Construction firms throughout the world love PFI. Taxpayers, watch out!
Construction is very much part of President Trump’s DNA. His $1 trillion infrastructure programme is based on $200 billion of federal cash pump-priming private spending by changing the structure of incentives to encourage investment. This appears to be an attempt to create the sort of Private Finance Imitative (PFI) that disfigured UK public investment in the New Labour years. Before Congress accommodates these proposals, its members would benefit from reading the reports of the UK’s Public Accounts Committee explaining the disappointing and expensive character of PFI.
The US federal government’s fundamental long-term fiscal problems are, at best, unchanged
Leaving aside its audacious economic assumptions, the President’s budget does not appear to address the federal government’s principal fiscal challenges. These consist of two generous and expensive social programmes, the Medicare health insurance programme for elderly people, and Social Security — a national insurance pension fund. The budget offers no proposals to contain their costs or benefits. On realistic assumptions, the federal government has insufficient recurrent tax revenue to meet its future spending commitments, and the Administration’s tax cuts and unrealistic scoring of revenue projections will aggravate them. This means that, on unchanged policies, the federal government has an unsustainable structural budget deficit. By 2027, the federal deficit will reach 5 per cent of GDP, and, as the annual deficits accumulate, it is projected by the CBO that the debt held by the public will rise from 77 to 89 percent of GDP. It is projected to reach $25 trillion, and would be at its highest as a share of national income since 1947, just after the end of the Second World War.
The great lacuna in US revenue collection: no comprehensive neutral expenditure tax
The US federal government has a further problem with its public finances: the tax revenue it does raise is in the form of income and corporation taxes, which are constructed in a manner that maximises their avoidable deadweight costs. That is why the US needs a fundamental reform in this area. The administration and Congress appear to be seriously interested in reforming the structure of these taxes, yet there seems to be no serious interest in the creation of a comprehensive and neutral expenditure tax of the sort used in Australia, Canada, and Europe.
Warwick Lightfoot’s book ‘America’s Exceptional Economic Problem’ will shortly be published. It explores the scope of the American public sector at the federal, state, and local level, and the awkward long-term challenges that policy makers in the US will confront.