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Based on the increase in stock prices since the election, investors believe the Trump administration is going to usher in faster economic growth.
Are they being too optimistic?
Tax cuts for individuals and corporations, which is a key component of President-elect Trump’s campaign promises, should support economic growth.
Since consumer spending makes up about 70 percent of U.S. gross domestic product, reductions in individual income taxes will support growth.
Not all of the tax cut will translate into spending, however, because some households likely will use the tax savings to pay down debt or increase savings.
Even so, the proposed Trump policies call for tax cuts in various degrees for all income groups.
Based on an estimate by the Urban Institute and the Brookings Institution, the plan would cut taxes by an average $2,940 in 2017 for households. The plan also calls for the elimination of the alternative minimum tax, the estate tax, and the gift tax.
Increasing productivity growth is critical to boosting the potential growth rate of the U.S. economy and improving living standards. This is where Trump’s promises of lower corporate tax rates and reduced regulation can make a big difference in GDP growth.
Cutting the corporate tax rate from the existing 35-percent rate to a 15-percent rate and repatriating overseas profits should boost profits to domestic firms.
These changes, combined with other policies allowing businesses to expense investments rather than depreciate them over a long period, should increase business investment in plant and equipment that will lead to productivity gains.
Promised reductions in business regulations, including key environmental and financial ones, also can increase productivity growth as increased regulations are generally associated with lower productivity growth. Many analysts expect changes to the Dodd-Frank law regulating financial institutions and the Clean Power Plan that affects energy companies.
Relaxing environmental regulations also will allow for more domestic energy exploration and production. This will increase the domestic energy supply and keep oil prices down. Lower oil prices can dampen future inflation, while increasing business investment and personal consumption at the same time.
On government spending, the new administration has promised to increase spending on military and infrastructure, which should stimulate economic growth.
On the other hand, Trump also vows to decrease the size of government agencies, which tends to reduce overall government spending.
The net effect of these policies will depend on whether some or all the plans are implemented.
Incorporating these policy changes into Chmura Economics & Analytics’ macroeconomic model indicates the proposed economic policies of the new administration can boost 2017 GDP growth by 0.6 percentage points, from 2.4 percent under the pre-election forecast to 3.0 percent.
For 2018, the new policies can increase GDP growth to 3.9 percent, up from 2.7 percent under the pre-election forecast.
In the new forecast, we assume that Trump’s trade policies impact both exports and imports, with a larger reduction in the growth rate of imports that reduces the U.S. trade deficit thereby increasing GDP growth.
With the presidency and both chambers of Congress under the control of the Republican Party, big shifts are likely regarding future economic policy. The longer-term effects of a Trump administration depend on whether economic activity increases enough to offset tax cuts and new spending as well as how other countries react to Trump’s trade policies.
And, of course, the midterm election in two years may impact the Trump administration’s ability to put in place new policies in the second-half of his term.