Donald Trump’s plans to invest in infrastructure could stimulate the U.S. economy and create jobs, but tax cuts could smother long-term growth, according to Kent Smetters, Wharton professor of business economics and public policy. Real U.S. economic growth, after inflation, is expected to be at 1.5% annually or so in the long run, he adds, citing projections from the Penn Wharton Budget Model that he runs as faculty director.
Smetters spoke of the likely impact of Trump’s post-election priorities on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Here are five takeaways from the conversation:
Infrastructure Investments in Sight: Trump will aim to stimulate the economy with investments in infrastructure, says Smetters. “There is wide agreement that infrastructure is collapsing,” and there is a need to replace it, which would also create jobs, he adds.
As for strengthening digital infrastructure, he says the private sector has a big role in securing networks. He notes that incidents involving hacking of digital networks occur often because companies have failed to adequately protect their systems. “Candidly, if a company is not protecting its own resources, the government is not going to be very effective at doing it,” Smetters adds.
Tax Cuts — Gains Now, Pains Later: Smetters says Trump has talked of reducing individual tax rates, especially for higher-income people. The tax reforms he proposes for businesses will stimulate the economy in the short run, he notes.
The Penn Wharton Budget Model shows the impact of various assumptions. “In the short run, it creates some stimulus, but over the long run, you lose a lot of revenue,” Smetters says of Trump’s business tax cut proposals.
The tax cuts will lead the government to increase its borrowings, which in turn will increase the debt with the general public, he explains. Such debt will compete with private capital for household savings and international capital flows. The short-term gains turn negative over time, and in fact become “very negative” over 10 years, Smetters points out.
“When you have less trade, and less capital flows, the impact of debt that would be created under his tax plans would be even bigger than it otherwise would have been.”
Social Security Shock: Older people, especially single women, would face dwindling finances if Trump’s policies constrain the government’s ability to fund Social Security benefits. Over half the people in the U.S. heading into retirement have Social Security as their biggest asset, says Smetters. The Penn Wharton Budget Model shows that the Social Security trust fund will run out of money in 14 years, although that is a more pessimistic prediction than what the Social Security Administration is predicting, he adds. At that point, only about three-quarters of Social Security benefits will be payable under current law, Smetters notes.
Those reduced payouts in Social Security benefits would hurt older people who have retired, Smetters notes. “At the same time, our demographic data also shows that singleness among older people is increasing,” he says. “That is because in one of the big, dramatic shifts that isn’t getting a lot of attention, the divorce rates amongst older people have gone up and we are projecting it would continue to go up.” He points out that it would especially be hard on older women, “who have tended historically to be the secondary earner.”
Bringing Back Corporate Taxes: In theory, Trump’s plan to force the repatriation of trillions of dollars of corporate taxes from overseas could happen, says Smetters. Trump’s plan to introduce a destination-based tax system would deter “a lot of the income shifting” to foreign tax havens, he adds. The other benefit he cites is that firms would show “less of a bias against the U.S.” in making their location decisions. Trump’s plan is similar to the Republican Party’s proposal of a destination-based tax to replace the current corporate tax regime and make it less attractive for U.S. companies to do “international tax planning and profit shifting,” Smetters notes.
Smetters finds some “smart things” in Trump’s proposals. One of those is moving towards expensing and away from interest deductibility. “Most economists agree that is a positive for investments, and we see that in our own model,” he says. But that is not balanced in terms of revenue, either with spending cuts or new sources of revenue, he points out. This again would lead to an increase in government debt, which will eventually compete with private capital and lead to economic contraction, Smetters warns.
“By 2040, growth would actually stop and the economy would start to contract at that point.”
Trade, Jobs and GDP growth: Trump policies for trade could lead the U.S. towards becoming a closed economy, says Smetters. “That would be a big negative over time,” he adds. “When you have less trade, and less capital flows, the impact of debt that would be created under his tax plans would be even bigger than it otherwise would have been.”
On speculation that the U.S. economy under Trump could grow at 4% annually, that is “not possible over a long period of time,” he says. “Over a long period of time, the growth rate is pinned down by the rate of technological change, and that is closer to 1% to 1.5% annually after inflation.”
In fact, the Penn Wharton Budget Model forecasts slowing economic growth in the years ahead, he notes. “By 2040, growth would actually stop and the economy would start to contract at that point.”