To balance the budget while cutting taxes, increasing military spending, and holding on to Donald Trump’s campaign pledge to avoid cutting Medicare is a challenging task to say the least.
In its first comprehensive budget proposal released Tuesday, Trump’s White House addresses that challenge in part by breaking his promise to avoid cuts to Medicaid and in part by claiming to believe that cuts to the Social Security Disability Insurance program don’t count as cuts to Social Security.
Beyond that, of course, reporting suggests that there will be steep cuts to most forms of domestic spending with a particular focus on cutting things like Supplemental Nutrition Assistance Program, also known as food stamps, that benefit the poor.
Even with those sharp cuts and broken promises, however, Trump would be projecting deficits as far as the eye can see without an assist from what Nick Timiraos at the Wall Street Journal says will be very rosy forecasts about economic growth. While the Congressional Budget Office expects the economy to settle into a pattern of growing at about 1.9 percent per year by 2021, the White House says growth will rise to 3 percent — way out of line with what forecasting experts in the private sector, at central banks, and at international institutions think will happen.
Obtaining 3 percent growth is harder than it sounds
For people over the age of 35 broadly familiar with the contours of American economic growth in the 20th century, the goal of 3 percent annual growth doesn’t sound outlandish because it’s something the country used to regularly achieve. Unlike Jeb Bush’s campaign promise 4 percent growth, there’s nothing particularly unusual about a sustained period of 3 percent GDP growth. So aiming for a return to that level has a veneer of surface plausibility.
Unfortunately, as an excellent report released last week by the Committee for a Responsible Federal Budget shows, it’s much less plausible than it sounds.
Their exercise lets you assume that productivity growth, labor force participation, and growth of capital (machines and business equipment) all return to 1990s levels and shows that even under that rosy scenario growth doesn’t quite reach 3 percent.
The reason is demographics. It’s true that productivity growth has slowed since the 1990s. And it’s true that the labor force participation rate has fallen, and business investment in capital goods has fallen. But over and above all that, the growth rate of the working-age population is slower. The very large baby boom cohort is aging out of its prime working years. The also large “millennial” generation is already big enough to be in the work force.
To get above 3 percent, you would need not only 1990s levels of productivity growth, labor force participation, and capital investment — you’d also need to go back in time and make sure that more babies were born between 1992 and 2002.
More immigration would boost growth
While time traveling pregnancies are impossible, there are of course other ways for a country to increase the size of its working age population — through, for example, more immigration.
Back in 2013, the Congressional Budget Office forecast that the immigration reform bill Congress was considering would deliver about a 3 percent one-off boost to GDP by increasing the size of the population, and add 0.3 percentage points to growth over the longer-term by building a more productive, more capital-rich economy. According to the CFRB’s overview of frequently considered policy proposals, that 0.3 percent growth boost is larger than just about anything else under consideration and many rival ideas — like tax reform — deliver no equivalent to the 3 percent one-off boost.
Beyond that, it’s fairly easy to imagine immigration reform schemes that would be even more growth optimized than the 2013 bill. That would primarily entail doing even more to increase the total number of immigrants allowed into the country, while trying harder to ensure that the largest possible share of those immigrants are well-educated 20-somethings who are poised to enjoy long and reasonably well-compensated careers in the United States.
There’s simply nothing else in the mix that can grow the economy at quite the pace of adding more people.
The Trump administration, of course, is tending to push policy in the opposite direction — curbing refugee admissions and using harsher internal enforcement measures to encourage long-settled undocumented people to “self-deport” and leave the country.
Trump’s growth forecast lacks internal consistency
One thing Trump’s budget forecast will have in common with other forecasts is a projection that interest rates on federal debt will stay low. Low interest rates make it relatively cheap to service the large amount of borrowing the United States did in the past, which reduces spending and thus reduces future borrowing. The assumption of very low interest rates is convenient, but also very defensible, with experts widely agreeing that borrowing costs are unlikely to explode in the near future.
But there’s a catch here. The near-universal presumption that interest rates are likely to stay low is intimately connected to the near-universal presumption that growth is likely to stay low.
With productivity growth and demand for business investment modest, the analysis goes, savers will be reasonably willing to park their money in federal bonds without asking for too much in compensation. After all, there won’t be great alternatives. But if growth and investment speed up, then the returns available to private sector investment should rise — pulling the rates investors charge to the federal government along with it.
Or to look at it another way: If growth surges in the way that Trump is forecasting, the Federal Reserve will be less cautious about guiding the economy to a higher interest rate environment. Either way, stronger growth means higher interest rates that will partially offset the improved budget outlook.
The White House, however, claims to believe that growth can accelerate to 3 percent with interest rates rising a mere 0.2 percentage points — to 3.8 percent — even though, as Timiraos writes, the historical “relationship between growth, inflation and interest rates implies Treasury yields of around 5 percent or more when growth is 3 percent.”
None of this really matters
The reason the numbers aren’t internally consistent is that, as we’ve known since February, the process used to generate them is profoundly unsound. Rather than let Council of Economic Advisers staff economists produce a forecast based on some kind of model, the Wall Street Journal reported that “transition officials [were] telling the CEA staff the growth targets that their budget would produce and asking them to backfill other estimates off those figures.”
Thus, you end up with exactly the growth and interest rate projections that are needed to make Trump’s budget proposal score as balancing the budget in precisely the final year of the 10-year scoring window.
It’s customary for the White House to produce a budget forecast that is a bit rosier than what Congress, the Federal Reserve, or private sector forecasts generate. It’s unusual for it to be so wildly at odds with the consensus.
That’s in part because most presidents lack Trump’s shamelessness. Another part is that most presidents would worry that if you order CEA staff to make up fake numbers, they will leak that to the Wall Street Journal.
But perhaps the biggest part is that normally presidents are trying, on some level, to work with Congress to get things done. Congress needs to use Congressional Budget Office numbers when legislating, so a fake White House forecast doesn’t help a president’s allies on the Hill. In effect, Trump is simply tossing congressional Republicans a hot potato — telling them that he is disavowing responsibility for any of the trade-offs inherent in governing, and that the responsibility is all on them to work things out.