What does Donald Trump’s return to the White House mean for the U.S. economy?
I believe there are two key areas in particular where Trump’s victory could produce economic benefits over the next four years. But there’s also a cost that will have to be paid.
Let’s start with taxes.
Nearly all of the provisions of the $1.5 trillion tax cut of 2017, which Trump signed into law in his first term, expire at the end of 2025. If those parts of the law aren’t extended, it would result in a tax hike of about $4 trillion through 2034. This would impose an additional burden on households coming out of a period of high inflation.
Extending the individual income tax cuts would keep marginal tax rates from jumping and lead – relative to letting them expire – to an increase in economic output in the long run. This occurs because lower taxes increase demand for goods and services in the short run. Lower tax rates increase the incentive to work, save and invest, which leads to more hours worked, more capital, increased labor productivity and new business formations in the long run.
The law also improved tax simplicity by doubling the standard deduction. And it promoted fairness by increasing the child tax credit, reducing how many taxpayers are subject to the alternative minimum tax and capping the deduction on state and local income taxes. The expiration of these provisions would result in a significant increase in the tax burden on many lower- and middle-income households.
I believe it’s a good bet that, at a minimum, Trump will extend the law. And many economists would argue that will be good news for American households and the economy as a whole.
More important are what I expect will be his more business-related policies that should promote innovation, investment and productivity, many of which also relate to the 2017 tax law.
A few of these policies also relate to the same tax law – and so are very likely to be extended or reformed early in Trump’s second term. Two provisions that are set to expire are the 20% small-business deduction and a measure that allows for the expensing of equipment such as computers and machinery.
The small-business deduction, which allows owners to deduct up to 20% of their share of the company’s income from their individual tax bills, was found to increase employment by 1.2 million jobs a year. It’s also important to ensure that small businesses remain competitive with larger rivals. Allowing businesses to fully expense the cost of equipment has been found to increase economic output by about 5% over the long term.
It’s important to extend these provisions to avoid a large tax increase on small businesses that would reduce job creation and innovation and lead to slower growth and lower living standards.
More broadly, Trump’s first term in office was characterized by a reduction in red tape. Research suggests the U.S. economy remains stifled by heavy-handed and poorly targeted regulations that slow growth and innovation. Trump has promised to further reduce regulations during a second term, so it could lead to solid gains in economic output.
But there’s one big caveat to this. Extending those tax cuts will put strain on the national debt, which is at unsustainable levels.
Since the turn of the century, U.S. debt has increased from $10 trillion to over $35 trillion.
Reforming the tax code to avoid a significant increase in taxes is important, but offsetting the revenue loss with spending cuts will be vital to avoid adding to the debt.
The start of the new administration is a perfect time to create a new fiscal commission to jump-start a bipartisan conversation on sustainable fiscal policy solutions.
John W. Diamond is director of the Center for Public Finance at Rice University’s Baker Institute. Distributed by The Conversation and The Associated Press.
