Not only will this tax plan pay for itself, but it will pay down debt.
—STEPHEN MNUCHIN, SECRETARY OF THE TREASURY, 2017
Hardly any political expert—one of my favorite oxymorons—saw Donald Trump coming. When the flamboyant real estate developer kicked off his campaign for the presidency by riding down a golden elevator at Trump Tower in Manhattan on June 16, 2015, few people took his candidacy seriously. The crowd that greeted him that day was small and, we later learned, some of them had been paid to show up. The main headline Trump made that day was accusing Mexico of sending the United States a bunch of rapists. MAGA hats would come later.
Trump had never held any public office or even ran for one, though he had flirted ostentatiously with running for president several times before. His 2015 effort, however, was for real. The Republican field was wide open; unlike the usual situation in which, according to the political aphorism, “Republicans fall in line,” there was no heir apparent. Trump had a masterful flair for publicity, had hosted a popular TV show for years, and had thrust himself into political notoriety by claiming (with no factual basis) that Barack Obama was not a U.S. citizen, the so-called birther claim. With his wealth, huge name recognition, finely honed ability to garner publicity, and keen understanding of how to manipulate the media, Trump propelled himself to the top of the pack in a fractious Republican field and remained there throughout the primaries.
Then in the 2016 general election, he shocked the world by defeating Democrat Hillary Clinton in the electoral college despite losing the popular vote by about three million votes (roughly 2 percentage points). Trump’s narrow upset victory—cobbled together by about seventy thousand votes in the states of Pennsylvania, Michigan, and Wisconsin—surprised just about everybody, probably including Trump himself.1
“Make America Great Again” was a pretty vague slogan, though it carried the clear implication that America was no longer great. Candidate Trump fleshed it out by railing against immigration (promising to build a wall that Mexico would pay for), trade agreements (such as the North American Free Trade Agreement and the recently negotiated Trans-Pacific Partnership), climate change (which he branded a Chinese hoax), and Obamacare (which Republicans had been trying to repeal ever since it was enacted). And he clearly wanted to cut taxes.
During the presidential campaign, Trump frequently insisted that recent GDP growth rates were far too low. The U.S. economy could grow much faster, he claimed, intimating that he knew how to make that happen. For example, in the televised presidential debate on October 19, 2016, he repeated his oft-made claim that “we’re bringing [the GDP growth rate] from 1 percent up to 4 percent. And I actually think we can go higher than 4 percent. I think you can go to 5 percent or 6 percent” (Politico 2016).
Mainstream economists wondered how Trump proposed to do that. Consider some obvious arithmetic: population was growing at less than 1 percent per annum, productivity was barely making 1 percent per annum, and resource utilization was presumably close to full employment, leaving little if any slack to take up. Those stark facts made many macroeconomists wonder whether even the recent 2.5 percent growth rate could be sustained. In fact, the Federal Reserve’s last published estimate of the growth rate of potential GDP prior to the election was only 1.8 percent, as was the Congressional Budget Office’s (CBO) January 2017 estimate for 2018. By the way, those modest assessments of potential GDP growth helped explain why the unemployment rate had fallen for years during the Obama presidency despite GDP growth in the 2.5 percent range. That meager speed was apparently faster than the growth rate of potential GDP.
None of these numbers bothered Trump and the Republicans, however. They lined up solidly behind what had become the standard Republican Party fiscal attitude since Ronald Reagan: No matter what the circumstances and no matter what the condition of the budget, always advocate tax cuts. Then hope for a supply-side miracle. Even if you don’t get it, taxes will be lower than previously.
To observers old enough to remember U.S. fiscal policy in the 1960s, the Trump tax cut proposal conjured up images of 1965, when President Lyndon Johnson piled a lot more federal spending on top of an economy that was already at full employment. The predictable result—which was in fact predicted at the time—was rising inflation from too much aggregate demand. Nonetheless, in 2017 President Trump was determined to pass what he insisted on calling the largest tax cut in history. (It wasn’t, though it was large.)
In addition to the incipient inflation problem (which did not materialize), the medium- to long-term prospects for the federal budget deficit looked terrible at the time, even though no one imagined what was to come in 2020. The CBO’s ten-year budget projection published in June 2017 saw the deficit ballooning from about $700 billion in fiscal year 2017 (3.6% of GDP) to almost $1,500 billion (5.2% of GDP) by 2027. And that was without the Trump tax cuts. The big reasons were escalating expenditures on Social Security, Medicare, and Medicaid, all items that had figured prominently in the fiscal debate for decades. Over that same period, the national debt held by the public was projected to soar from 76.7 percent of GDP to 91.2 percent (CBO 2017b). Deficit hawks were alarmed.2 Republican members of Congress, eyeing big tax cuts, were not.
The Tax Cut and Jobs Act of 2017 was a complicated piece of legislation that turned out to be the lone major legislative achievement of the Trump administration. (President Trump did accomplish many other things but mainly through executive orders and refusal to enforce regulations.) Supporters of the act touted it as an important tax “reform” that would improve incentives, reduce distortions, and simplify the tax code, thereby giving the economy a big boost from the supply side. There were in fact a few elements of simplification and (arguably) some loophole closings in the act. But this alleged tax reform also opened up some gigantic new loopholes (especially for pass-through entities) and added new complexities to the code. A fair assessment would probably be that it was much more of a tax cut than a tax reform, just as the law’s title says.
Major changes embedded in the Tax Cut and Jobs Act included reducing tax rates for both businesses and individuals, eliminating personal exemptions but increasing the standard deduction (which did constitute simplification), limiting deductions for state and local income taxes and property taxes (a tax hike clearly aimed at residents of blue states), and reducing the estate tax. The corporate tax cut was particularly large: the basic tax rate was reduced from 35 percent to 21 percent and expensing was substantially liberalized, all without closing loopholes to recoup some of the lost revenue.
Kevin Hassett, who chaired Trump’s first Council of Economic Advisers, frequently repeated the claim that the large corporate tax cut would (eventually) raise household incomes by about $4,000 a year, a large increment, and that some of this benefit would start accruing right away (CEA 2017). The presumed mechanism was that the tax cut would lead to a surge in business investment, which would raise productivity and hence real wages. Note the familiar ring of this line of logic. Would-be deficit reducers had argued for years, even before Bill Clinton’s election, that lower budget deficits would crowd out less business investment, thereby boosting productivity and real wages. Could both a fiscal contraction and a fiscal expansion have the same salutary effect? That seemed implausible. But Hassett’s argument was different. It came from the supply side and was all about tax incentives, not about interest rates.
As it turned out, the share of real nonresidential fixed investment in real GDP rose from an average of 14 percent in 2016 and 2017 (the tax cut passed in December 2017) to an average of 14.7 percent in 2018 and 2019 (before the coronavirus hit). The direction was right, though the increment of 0.7 percentage point could hardly be called a surge. The whole episode brought to mind Charles Schultze’s old quip that there was nothing wrong with supply-side economics that dividing by ten couldn’t cure.
Notably, the corporate tax cuts were legislated to be permanent, while the rate cuts for individuals and pass-through entities were scheduled to fade out over time. That last feature was redolent of the budgetary gimmickry used to reduce the cost of the Bush tax cuts in 2001 and later President Joe Biden’s Build Back Better proposals in 2021. It enabled the Senate to pass the bill under budget reconciliation, thereby obviating the need to defeat a filibuster.3 With all that, the bill barely squeaked through the Senate with just fifty-one votes. It was quickly signed into law by President Trump on December 22, 2017.
Regarding the size of the tax cut, the CBO estimated that individuals and pass-through entities (partnerships and S corporations) would receive about $1,125 billion in net benefits over ten years, while corporations would receive around $320 billion. All told and including debt service, the CBO estimated that implementing the Tax Cut and Jobs Act would add about $2.3 trillion to the national debt over ten years, or about $1.9 trillion under dynamic scoring that took account of macroeconomic feedback effects.
Those numbers made it a large tax cut for sure, roughly 1 percent of GDP, but a far smaller share of GDP than, say, the Reagan tax cuts of the early 1980s, which were closer to 3 percent of GDP (though phased in over three years). The Trump administration disputed these (and other) estimates of revenue losses, however. In fact, both the president and his secretary of the treasury, Stephen Mnuchin, actually claimed that the tax cuts would stimulate so much economic activity that they would more than pay for themselves (see this chapter’s epigraph).4 It was Laffer redux.5
As noted, the debt-to-GDP ratio was already projected to rise sharply before the Trump tax cuts were enacted. With the tax cuts, it would rise even faster. Treasury yields did rise a bit at first; the ten-year rate went from about 2.5 percent when the tax bill passed in December 2017 to about 3.1 percent in May 2018. But then rates stabilized for months before beginning a notable decline in November (figure 17.1). As a general matter, the larger Trump deficits did not seem to spook the bond market. Perhaps traders were delirious with joy over their own reduced tax liabilities.
Amazingly for a tax cut, however, the Trump tax cuts never proved popular with the broad American public. Just before the law passed, only 34 percent of Americans polled by Gallup thought the tax cuts would help their family’s finances; 57 percent said it would not. Only a few percentage points more thought it would help the national economy (Gallup Organization 2017). Two years later the bill remained unpopular, and Americans remained confused about its provisions. Tellingly, only 14 percent thought their taxes had been reduced (Brenan 2019). One obvious reason, emphasized by the law’s critics, is that the tax cuts, taken as a whole, were remarkably regressive, showering benefits on corporations, pass-through businesses, and large estates while many households of modest means received little if anything.
FIGURE 17.1. Ten-year Treasury yield, 2015–2020.
Source: Board of Governors of the Federal Reserve System.
On the spending side of the budget, the partisan wars of the Obama years morphed into a series of less dramatic skirmishes, leading to stopgap spending bills (“continuing resolutions”) in May 2017, September 2017, December 2017, January 2018, and February 2018 until a genuine agreement was reached in March 2018. The most notable of these agreements was the September 2017 budget-busting deal reached mainly by Trump, House minority leader Nancy Pelosi, and Senate minority leader Chuck Schumer, with relatively little input from congressional Republicans despite their majorities in both chambers at the time. That deal, which averted a debt ceiling crisis, raised the caps on discretionary spending by about $300 billion over two years. Later those same spending caps were essentially inscribed in the March 2018 budget agreement, which narrowly averted a government shutdown.
Trump, though bellicose by nature and perhaps the most partisan president the country has ever known, showed little appetite for either a government shutdown or brinkmanship over the national debt ceiling, both of which had become standard Republican fare since the Clinton administration. Instead, the bipartisan budget deal of 2017–2018 added more stimulus on the spending side to the large stimulus already coming on the tax side. Hardly any congressional Republicans expressed concern about the widening budget deficit. They were, however, disappointed by Trump’s propensity to deal mostly with Democrats on spending and also by his failure to mount a serious attack on the welfare state, a long-held Republican wish.
There was one big exception, however: health care. The president enthusiastically joined congressional Republicans in their efforts to “repeal and replace” President Obama’s signal achievement: the Affordable Care Act. Amazingly, they were attempting to repeal Obamacare without replacing it, for the Republicans never came up with an alternative plan. Several attempts at repeal passed the House but failed narrowly in the Senate. The last of these went down in particularly dramatic fashion in the wee hours of July 28, 2017, when an ailing Senator John McCain (R-AZ), the party’s standard-bearer in 2008, turned a “thumbs down” (literally) in the well of the Senate. McCain died about a month later. But the effort to repeal Obamacare legislatively died that night in the Senate.6
As early as 2015, while still a candidate for the Republican nomination, Trump began attacking the Federal Reserve in general and its chair, Janet Yellen, in particular. His charge at the time was that she was keeping interest rates too low for political purposes, specifically to support the Obama economy and thereby assist the Democratic nominee, who was widely expected to be Hillary Clinton. In October 2015, Trump told Bloomberg that “Janet Yellen for political reasons is keeping interest rates so low that the next guy or person who takes over as president could have a real problem” (McMahon 2015). In September 2016, speaking then as the Republican nominee, Trump said that Yellen should be “ashamed of herself” for keeping interest rates so low and creating a “false stock market” to help Clinton win the election (La Monica 2016). These are just two of many examples. Trump’s anti-Fed, anti-Yellen drumbeat was incessant.
The relationship improved a bit when candidate Trump became president in January 2017. But in early November 2017 he decided against retaining Yellen as Fed chair for another four years, opting to replace her by promoting Jerome “Jay” Powell, who was then a Fed governor. Powell was a Republican—something very important to Trump—though far from a Trump Republican. At the Rose Garden announcement at which Trump introduced Powell, the president was complimentary: “He’s strong, he’s committed, he’s smart. I am confident that Jay [will be] a wise steward of the Federal Reserve” (Swanson and Applebaum 2017). Years later, most observers judged those words to be accurate. But Trump himself basically ate them.
The new president’s other early appointments to the Federal Reserve Board were also mainstream; they gave no impression that the White House was at war with the Fed or trying to pack it with acolytes or quacks.7 On the contrary, Randal Quarles, who joined the board in October 2017 as vice chair for supervision (a post Obama had left vacant), and Richard Clarida, who became the Fed’s vice chair in September 2018, were both experienced and well-qualified Bush Republicans. Indeed, both had served in George W. Bush’s Treasury Department. They were confirmed easily by Senate votes of 66–33 and 69–26, respectively.
Trump’s honeymoon with the Fed was short-lived, however. Powell took over the helm from Yellen on February 5, 2018. As noted earlier, Yellen had led the Federal Open Market Committee (FOMC) to raise interest rates three times during 2017, each by just 25 basis points. The Powell Fed followed almost the same script, pushing rates up four times during 2018, again by 25 basis points each time. Even after those seven rate hikes, however, the federal funds rate was barely positive in real terms: just 2.25 to 2.5 percent against an inflation rate around 1.75 percent. Arguably, monetary policy was close to neutral. But the president of the United States didn’t see it that way.
In an unusual display of restraint for him, Trump somehow held his tongue after the Powell Fed’s first rate hike in March 2018. Trump’s personal dam broke, however, when the FOMC raised rates again that June. “I’m not thrilled,” he told CNBC. “I’m not happy about it.” Yet, he allowed as to how Powell—his own appointee—was “a very good man” (Cox 2018). By Trumpian standards, it was a mild rebuke, certainly not accompanied by any sort of threat.
Things went downhill from there, however. After the FOMC raised rates again in late September 2018, Trump told a campaign rally that “they’re so tight. I think the Fed has gone crazy,” adding a few days later that the central bank was “going loco.” He later called the Fed the “biggest threat” to the growth of the U.S. economy even though he recognized that the central bank is “independent so I don’t speak to them.” Trump also said that he was not going to fire Powell, as if he had the authority to do so. Shortly after the FOMC took the funds rate up another 25 basis points on December 19, 2018, Trump tweeted that “the only problem our economy has is the Fed” (Condon 2019).
The FOMC held the funds rate steady, in the 2.25 to 2.5 percent range it had established in December 2018, through July 2019. But the central bank’s long pause did not induce a corresponding pause in Trump’s criticism of monetary policy. In June 2019, for example, the president told CNBC that the Fed had “made a big mistake. They raised interest rates far too fast” (Oprysko 2019).
In 2019 real economic growth was mediocre and inflation continued to run below target, but words such as the president’s made it hard for the FOMC to reduce rates without appearing to cave to White House pressure. The FOMC did so anyway, starting with a rate cut of 25 basis points on July 31. The FOMC statement said the rate cut was done “in light of the implications of global developments for the economic outlook as well as muted inflation pressures.” Two district bank presidents (Esther George of Kansas City and Eric Rosengren of Boston) dissented against the cut, preferring to hold the funds rate constant. Many outside observers attributed the Fed’s move—as well as the two rate cuts that followed—to the deleterious macroeconomic effects of the White House’s trade war with China.
But Trump was far from placated. In August, he tweeted that “the only problem we have is Jay Powell and the Fed. He’s like a golfer who can’t putt, has no touch” (Elliott 2019). On September 11, the president lambasted Federal Reserve decision makers as “boneheads” and said that interest rates should be zero or negative. One week later the FOMC cut the funds rate by another 25 basis points, with George and Rosengren again dissenting. Then on October 30, 2019, the FOMC made one final cut of 25 basis points, with the same two dissents, setting the federal funds rate range at 1.5–1.75 percent. Since that was about the same as the inflation rate at the time, the real funds rate was approximately zero.
Good enough? Well, not quite. About two weeks later, Trump blasted the Fed again in a speech to the Economic Club of New York. It was a strange venue to choose for an attack on the central bank; the Wall Street–dominated club is about as Fed-friendly an audience as you can find outside the Fed’s own buildings. A few days later, Powell met with the president at the White House in a meeting described as “cordial.” But Trump continued to call for lower rates. The Fed, as it turned out, was finished cutting rates. But the president was not finished complaining that rates were too high. For whatever reasons, however, the verbal war between the White House and the Fed went comparatively quiet after that. Soon the pandemic started consuming everyone’s attention.
Donald Trump, you will recall, promised a sharp acceleration in economic growth, presumably sparked by the tax cut. But he did not deliver on that pledge. From 2017:1 through 2019:4 (before the pandemic struck), real GDP growth averaged the same boring 2.5 percent per annum that had prevailed for years before. Perhaps more important politically, however, weak productivity performance continued to translate that mediocre GDP growth into strong job growth, just as it had for Obama. Net job creation averaged slightly less in the first three Trump years than it had during the preceding six Obama years: 2.19 million net new jobs per year versus 2.44 million. But it was still notable.
FIGURE 17.2. Unemployment rate, 2010–2019.
Source: Bureau of Labor Statistics.
The unemployment rate, which had tracked down from a peak of 9.9 percent (in March and April 2010) to just 4.7 percent in Obama’s last month in office (January 2017), continued to decline, reaching a fifty-year low of 3.5 percent in September 2019. There is no observable acceleration of that downward trend after January 2017 (figure 17.2). In fact, a regression test detects a tiny flattening of the curve after that date, which is the “wrong sign” for the Trump claim. But basically, the preexisting downward trend just continued until the pandemic interrupted the ongoing experiment to see how low the unemployment rate could go.
In short, if you ignored the name on the White House door and looked only at the economic numbers, you could not tell when the “Obama economy” ended and the “Trump economy” began. That said, the state of the economy on the eve of the pandemic was excellent: record-low unemployment, especially for minorities; reasonable rates of net job creation; moderate GDP growth; and very low inflation. As Trump was making plans for his 2020 reelection campaign, the economy looked like his strong suit.
Fiscal policy had boosted the budget deficit from 3.4 percent of GDP in fiscal year 2017 to 4.6 percent in fiscal year 2019, but no one except a few policy wonks cared about that. In fact, even within that small community, a new view had begun to take hold: that with interest rates so low and the world’s demand for safe assets such as U.S. treasuries so high, there was room to push the national debt considerably higher.8 Regarding monetary policy, the federal funds rate target range was 100 basis points higher in December 2019 than it had been in January 2017. So, monetary and fiscal policy were, in the literal sense, clashing as they had in Reagan’s first term. But the clash was not sharp. In general, the situation was sunny, as was the outlook.
Donald Trump inherited a strong economy in January 2017. GDP growth was mediocre. But with productivity growth so weak, jobs were being created at a healthy enough pace to keep the unemployment rate tracking downward. (It finally hit a fifty-year low of 3.5 percent in September 2019.) Trump was not content to leave well enough alone, however. (Was he ever?) He had run on a campaign promise to cut taxes, and the Republican-dominated Congress did exactly that in December 2017. He had also run against both the Federal Reserve’s leadership (Janet Yellen at the time) and its policy of low interest rates. His attitude regarding the latter changed dramatically on election day 2016, however, from sharp criticism that interest rates were too low to railing against keeping interest rates too high. In early 2018, Trump replaced Yellen with Jay Powell as chair of the Fed.
The highly partisan Trump tax cut of December 2017, coupled with a bipartisan relaxation of spending caps in 2018, provided significant fiscal stimulus to an economy that most economists thought was already near full employment. Yet inflation did not rise, just as it had not in the late 1990s. In fact, the Fed’s inability to push inflation up to its 2 percent target, coupled with concerns over what the trade war with China would do to the economy, induced the Fed to switch from raising rates (slowly) in 2017 and 2018 to cutting rates (slowly) in 2019.
The effects of the fiscal stimulus on real growth appear to have been minor. The growth rate of real GDP, which had averaged 2.3 percent over the years 2015, 2016, and 2017, rose to 2.5 percent and 2.4 percent in 2018 and 2019.9 Small beer, you might say, almost certainly smaller than measurement error. The Fed’s switch to more expansionary monetary policy in 2019 was also minor, just 75 basis points in total. But the pandemic of 2020 turned the lights out before anyone could draw a judgment on its effects or on how low unemployment could go. Soon, both fiscal policy and monetary policy faced a far darker situation.
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1. See, for example, Jacobs and House (2016).
2. See, for example, CRFB (2017).
3. The special reconciliation procedure allows budget-related measures to pass the Senate by a simple majority vote rather than the usual sixty votes needed to terminate debate.
4. See, for example, Davidson (2017).
5. The icing on the cake: Most economists winced in June 2019 when President Trump awarded Arthur Laffer a presidential medal of freedom. See, for example, Weissmann (2019).
6. But not judicially. A court case that threatened to repeal Obamacare judicially was filed in February 2018. It went all the way to the U.S. Supreme Court, where in June 2021 the justices rejected the suit on lack of standing.
7. That was unlike most of Trump’s subsequent selections. He sought to put Herman Cain, Stephen Moore, and Judy Shelton on the Federal Reserve Board. None of these controversial choices made it through the Senate. Trump’s one late-term mainstream candidate, Christopher Waller, did, however.
8. See, for example, Blanchard (2019).
9. I divide the years this way rather than by political administration because the Trump fiscal stimulus began in the closing days of 2017.