Tax Cuts and Growth Revisited

If the U.S. economy does now have a year of GDP growth considerably higher than what it was in the past decade, it will probably lead into some political lies of the future related to tax cuts and growth. If government officials actually care about better economic growth, they’ll implement policies that invest in technological advancements and employment programs that increase capacity utilization. This growth should then go to the general public instead of the minor faction of the population that’s already wealthy.

The Democrats were virtually unanimous in opposition to the tax cuts that Republicans pushed through Congress last year. They had good cause. The overwhelming majority of the tax cuts go to the richest 1 percent of the population, the same group that has gotten the bulk of the gains from economic growth over the last four decades. For those who don’t think making the rich richer is an important priority of government, the tax cuts were a really bad idea.

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While there is little reason to believe that the tax cuts would lead to the sort of boost in growth claimed by proponents, it is actually very plausible that GDP growth could average 3 percent over the next decade.

There are two factors that determine GDP growth: the rate of growth of the labor force and the rate of growth of productivity. The rate of labor force growth is almost certain to be slower going forward simply because the massive baby boom cohort will be retiring over the next decade.

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This matters hugely because there is some reason to believe that productivity is picking up for reasons having nothing to do with the tax cut. Productivity growth averaged 2.1 percent in the second and third quarter of last year. It then fell slightly in the fourth quarter due to quirks in the data, specifically a surge in the number of people reported as self-employed. But with early reports indicating first quarter GDP growth will be well over 3 percent, we are likely to see another quarter of strong productivity growth.

While this uptick cannot be plausibly explained by the tax cut, there is an alternative explanation: It may simply be the result of a tighter labor market. The tighter labor market has led to increased wage growth at the bottom end of the pay ladder.

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This all matters from a political standpoint because it would be unfortunate if the Republicans were to get credit for a pickup in growth which has nothing to do with them. Some of us did try to warn of this possibility last year, but the leading Democratic economists were not interested in our assessment.

Just to repeat what we said then, it is very possible that we will see something like the 3 percent GDP growth promised by the Republicans, but not because we gave more money to rich people. Because so many denied this possibility, Democratic economists may end up helping to convince people that giving money to the rich is the key to a strong economy.