Why the Economy Cannot Cut the Budget Deficit

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In the 2018 fiscal year, the federal budget deficit rose to $779 billion, up 17% from the year before. This did not include the full force of federal tax cuts or the odd assumption that tariffs will improve the economy. It is plain that the only thing that can start to begin to push the deficit down is an economy so strong that it causes a surge in federal government receipts. The argument has been made before and has rarely yielded a positive result.

Tax cuts may have improved the chance that corporate results will go up. The cuts will allow companies to invest more in products and R&D. Those cuts will increase customer demand because customers have more money. Net-net, the business cycle will improve sharply because of sales and profits increases. The cuts also have caused some corporations to return money to the United States from offshore. Those companies will use the cash to add more workers, increase R&D spending and create new products. If the same companies put money into shareholders profits as an alternative to internal investment, those shareholders will have more money to spend into the consumer economy.

On the consumer side, which represents over two-thirds of gross domestic product (GDP), these consumers will spend their money at an accelerated pace. That means more sales for companies. Some of this money may have come from the tax cuts they have enjoyed. Another factor is low unemployment. Yet another is all the money they have or will make in the stock market. The value of their homes has risen over the past few years. They can use that equity to increase their consumption. And they probably won’t save much money when they can spend it instead.

No one knows how much GDP has to rise to create revenue that will offset higher federal government spending. The sum must be much higher than the 3% to 4% level, though it is forecast by many to fall below 3%. Maybe the number has to be 5% or 6%. No one believes that will happen.

The theory about policies that will trigger sharp increases in federal government revenue is flawed because they cannot put a rocket under GDP. Without that, deficits will continue to rise.