Americans must pay higher taxes if they want to keep a high standard of living

By Peter Morici

Financial challenges face the next U.S. president - but one candidate's remedies would be a 'train wreck'

No matter who wins the presidential election in November, the U.S. government faces daunting fiscal challenges that will have to be met with higher taxes.

The CBO projects the U.S. federal deficit will grow to 6% of GDP in 2033 from 5.6% this year. Debt held by the public will increase to 114% of GDP from 99% and continue rising. These projections assume 2% inflation and real GDP growth, interest rates falling significantly from current levels, non-defense discretionary and defense spending growing in line with inflation, and current policies and laws unchanged.

The 2017 Tax Cut and Jobs Act (TCJA) simplified and cut individual income taxes and lowered business taxes - the combined average federal and state corporate rates at 26.5% is now just about in line with rates in Europe.

The TCJA was passed under reconciliation rules, which required no negative budget deficit impacts beyond a 10-year window. Consequently, under current law, most of the individual tax cuts expire at the end of 2025 while most of the corporate tax reductions continue.

Tax, spend and borrow

President Joe Biden's proposed budget would effectively repeal the benefits for families with incomes over $400,000, raise taxes on the wealthy and boost the federal corporate rate to 28% from 21%.

Most of Biden's tax increases are unlikely without the Democrats winning control of Congress; the Senate electoral map is more favorable to Republicans this year.

If former President Donald Trump is elected again, the TCJA will likely be extended. This would cost at least $3.3 trillion through 2033 and would raise the debt held by the public to far more than the CBO forecast of 114% of GDP by 2033.

Borrowing costs would soar. Last July, the Treasury announced a substantial increase in its borrowing requirements to rebuild cash balances after the budget ceiling standoff in Congress. That instigated a full percentage-point jump in the 10-year Treasury rate (TY00) to nearly 5% by late October.

Without the personal income-tax provisions of the TCJA expiring or other radical changes, U.S. debt will grow to at least 120% of GDP over the next several years. Interest payments would likely be at least 6% of GDP and be growing faster than nominal GDP.

This could trigger a flight from Treasurys in international markets - effectively, a vote of no-confidence in the U.S. dollar (DX00) as the global reserve currency and boosting the prominence of the Chinese yuan (CNYUSD).

At that point, either the Federal Reserve would have to allow interest rates to rise, limiting investment and growth, or it would print money to purchase Treasurys. That printing would trigger significant inflation that would act as a tax on Americans' living standards in order to fund the government.

Furthermore, Trump has proposed a 60% tariff on imports from China and a 10% tariff on all other imports. Also he is reportedly considering lowering the federal corporate tax rate to 15% from 21% - at a cost to the U.S. Treasury of an additional $250 billion through 2033.

In 2023, U.S. goods imports were $3.1 trillion with an average tariff of about 2.2%. Trump could afford to maintain the TCJA personal income-tax cuts and lower corporate taxes by imposing his import tariffs, but that would also require letting U.S. defense spending continue to decline as a share of GDP per CBO current projections - not a likely prospect.

Important in all this, the price elasticity of export demand for Chinese goods appears quite low. Additional tariffs won't lower the volume of U.S. purchases much.

Trump 'train wreck'

Put simply, Trump's proposals would leave the nation's finances on track for a train wreck.

Higher tariffs would be partially paid by foreign producers, but most of the cost would be borne by consumers. Relying on tariffs would be even more regressive than letting the TCJA personal-tax provisions expire, because poorer households spend larger shares of their incomes and save less than the wealthy.

Leaving the federal corporate tax at 21% would be desirable, because there's significant evidence that TCJA encouraged more business investment. Raising the tax to 28% would give the U.S. the highest combined national and subnational rate among large Western industrialized countries.

Many of the new investments in AI - especially foundation models - are being financed by retained earnings from Big Tech. Reducing that pool of capital threatens U.S. leadership in AI, and the funds needed for U.S. industry to catch up in electric vehicles and batteries and build a greener energy system.

To accommodate adequate defense spending, avoid draconian cuts in benefits to seniors and the social safety net, and invest in new industries, either America will have to embrace much higher personal income taxes or suffer slower growth and significant inflation.

Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

More: 'Bidenomics' 2.0 or 'Trumponomics' 2.0? Both would hurt trade and growth.

Also read: A massive earnings surge could lift the Dow to 60,000 and the S&P 500 to 8,000, says top Wall Street strategist

-Peter Morici

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05-25-24 1126ET

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