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Jonathan Chait
raises a good point, which many of us were already thinking about: for
all the debate about whether the tax bill will partially pay for itself,
it’s actually more likely that it will end up worsening the deficit by
far more than most estimates suggest. The reason is simple: the bill is
junk, hastily drafted and full of exploitable loopholes. Once the tax
lawyers and accountants get to work, they will probably find ways for
their clients to avoid hundreds of billions in taxes that even the JCT
estimates still assume will be paid.
Suppose
this is indeed what happens. I’ve been trying to think through the next
step: What effect will a ballooning deficit have on markets and the
political climate?
When
it comes to markets, my conclusion is, not much. The tax bill might
lead to somewhat higher interest rates, but probably not to an interest
rate spike. Why not?
You
might think that I’m making the same argument I was making during the
aftermath of the financial crisis, when I argued repeatedly – and
correctly – against predictions that budget deficits would lead to
soaring rates. But my reasoning now is different, because both the
underlying economic situation and the source of the deficits is
different.
Back
in 2009-10, we had a deeply depressed economy with monetary policy at
the zero lower bound, which meant basically that desired saving exceeded
desired investment. So government borrowing wasn’t competing with the
private sector for a limited supply of funds, it was giving idle
potential saving a place to go.
These
days we’re much closer to full employment, and the Fed is gradually
raising rates, so it’s an entirely different situation. But if you want
to claim that deficits will drastically raise rates, you need to spell
out the channel; and I think that channel would be largely blocked.
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First
of all, the U.S. isn’t going to go bankrupt; it can’t run out of money
to pay its bills (except for political holdups), because it can print
money. And we’re a long way from the kind of situation in which America
would become so dependent on the printing press that we’re looking at
potential hyperinflation.
What
this means is that monetary policy – basically, short-term interest
rates — will be set by the Fed based on economic conditions. And
long-term interest rates will, to a first approximation, be the average
of expected future short rates, so they too will reflect expected
economic conditions.
So
the only way big deficits could drive up rates would be if they gave a
big boost to demand, threatening to overheat the economy, and causing
the Fed to raise rates to avert that overheating.
Which
means that the market impact of deficits depends on how much we think
these deficits will raise demand. And the answer is, probably not all
that much – if you think of the tax bill as a form of demand stimulus,
it’s a very ineffective one, and the piece of the deficit that comes
from gaming incompetent legislation will be especially ineffective.
For
one thing, the bulk of the gains will go to the rich, who probably
spend less of a marginal dollar. And this will be especially true for
rich people receiving what they suspect will be transient income gains.
So,
imagine yourself as a wealthy, liquid taxpayer experiencing a surge in
after-tax income because your accountant has found clever ways to
exploit the idiocy of new legislation. It will be fun and lucrative, but
you’d have to suspect that the fun will end eventually – that even this
GOP, with this leadership, will eventually close the most outrageous
loopholes. So we might see big deficits that have relatively little real
effect, because the winners from system-gaming save most of their
gains.
Notice,
by the way, that this isn’t the conclusion I’d like to reach on
political grounds. Given how terrible this bill is, I’d like to claim
that it will lead to immediate market disaster. But I try not to engage
in motivated reasoning (although sometimes I give in to temptation, then
apologize); and I just don’t see a market disaster even if we see the
expected epidemic of tax avoidance.
What
about the politics? OK, here I don’t have a clear model, so this is
much more speculative. Still, what happens if the deficit balloons, and
it’s clear that gaming of the tax bill is a major factor?
We
know what Ryan and McConnell will try to do: they’ll try to use
deficits as an excuse to cut safety-net programs. But will they be able
to get away with this with the memory of the tax scam still fresh in
everyone’s memory? I’m pretty cynical about centrists and the propensity
of the media to be taken in by charlatans, but I think this would
probably be a bait and switch too far.
Put
it this way: Republicans would surely use big deficits as an excuse to
propose big cuts in social programs, but they’d face a barrage of
hostile media coverage, plus lots of public demonstrations as in the
case of health care, all reminding everyone that these deficits were
created by their own dishonest promises just a few months earlier.
And
imagine, as we should, that all of this would go along with many
front-page stories about dubious business types abusing the new
loopholes. Doesn’t this sound like a political disaster for the GOP?
They
could, of course, simply ignore the deficit and leave Medicare alone.
But my guess is that they won’t be able to help themselves, that they’ll
be prisoners of their own rhetoric even as the most unpopular
legislation in history becomes pure political poison.
So
that’s my prediction: minor market impact, but quite probably a
political disaster for the GOP as it becomes even clearer that their tax
policies reward scammers.
Of course, all this may be overshadowed by constitutional crisis. But that’s for another essay.
Follow me on Twitter (@PaulKrugman) and Facebook, and read my blog, The Conscience of a Liberal.Follow The New York Times Opinion section on Facebook and Twitter (@NYTopinion), and sign up for the Opinion Today newsletter.
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