Tax bill runs risk of overheating an already revved-up economy, analysts warn

Reporting from Washington —  For President Trump and Republican lawmakers, economic prospects may never look better than today.

The economy is poised for what most analysts expect to be the best performance in years — a rare moment of synchronized global growth that has been lifting U.S. manufacturing and demand at home.

Mere anticipation of the Republican tax plan, which won final approval on Wednesday, has given a “Trump bump” to stock prices and business confidence.

Unemployment is at its lowest level since December 2000.

“If we can’t sell this to the American people, we ought to go into another line of work,” Senate Majority Leader Mitch McConnell of Kentucky told reporters early Wednesday morning after the tax bill passed his chamber.

McConnell was referring specifically to the tax bill, but his words apply to the overall economic picture, as well: Events have handed Republicans an economic gift. Their inability, so far, to convert that good economic news into political gains is almost without precedent.

Now, with the tax bill’s passage, the positive economic news comes wrapped around a kernel of worry: It could turn out to be too much of a good thing, economic analysts warn.

The worry is not about the details of the tax package, controversial and uncertain as they are. Rather, it is the very robustness of the American economy.

No expansion lasts forever. The current surge is 8½ years old. By spring, it will be the second longest expansion in American history.

With the tax cuts, U.S. growth may get an extra short-term boost, accelerating to as much as 3% across the year in 2018, a figure not reached in a dozen years.

But extra fiscal stimulus, coming at a time when the economy already is perking, could quickly lead to overheating, the analysts say.

“Simply stated, we are adding substantial stimulus to an economy already operating near full capacity,“ Northern Trust economists Carl Tannenbaum and Ryan Boyle said in a research note Tuesday evening, shortly before the Senate approved the tax bill 51 to 48, strictly along party lines.

Mark Zandi, chief economist at Moody’s Analytics, issued a similar caution: The poor timing of these tax cuts, which are financed largely by increasing the federal deficit, “washes out most of the benefits,” he said.

As labor markets tighten, many employers will increasingly struggle to find workers, putting upward pressure on wages.

That, in turn, could lead to faster inflation, higher interest rates and a tightening of the business cycle – pushing the country toward a recession.

So, Trump and GOP lawmakers may want to enjoy the moment while it lasts.

Most of what makes the current economy so strong is a matter of inheritance. Aside from recoveries in Europe, Japan and even Russia and Brazil, the U.S. is benefiting from the result of decisions made years ago about how to get the country out of the 2008 financial crash — the worst economic crisis since the Great Depression.

Most experts say that quick government action in late 2008 and early 2009 staved off immediate disaster and saved major industries and tens of thousands of jobs. Creative but careful monetary policy in the following years led to a slow but steady recovery.

The results of those efforts would have been inherited by any president, Republican or Democrat.

The question now is, what next?

Many experts, including Federal Reserve policymakers, have recently marked up their growth forecast for next year by about a half percentage point. but the Fed and some private economists do not see the Republican tax plan buoying the economy beyond the short term.

The Tax Cuts and Jobs Act, as the bill is formally titled, could give many workers bigger take home pay as early as February with adjustments in their tax withholding. The biggest benefits, however, will be reaped by wealthier Americans, and unlike the tax bill’s corporate cuts, the changes to the individual tax code are temporary.

By 2027, the average tax rate will increase for all persons with incomes less than $75,000, with taxes rising several years earlier for the lowest income taxpayers, according to Congress’ Joint Committee on Taxation.

Republican leaders as well as some economists argue that the tax cuts can — and will — have a powerful and enduring effect on growth by spurring greater investments. That, in turn, will raise productivity and wages, they predict.

Many independent economists say that will be a big challenge in an economy already at or near full employment. Corporations already have had no shortage of cash to invest, they note, and the jobless rate at 4% is close to the minimum that most economists think a healthy economy can sustain.

It’s also hard to know how much further stocks can keep climbing. Even before Trump took office, the broad S&P stock market gauge was up 200% from its bottom in 2009. The index has climbed another 20% this year.

“What the central banks have given the markets over the last few years could be taken away should fiscal stimulus boost inflation pressure,” said Jack Ablin, chief investment officer at ‎BMO Wealth Management in Chicago.

Moreover, the tax cuts are widely expected to add substantially to federal debt. That will put upward pressure on interest rates and hamper private investment as more savings are diverted to buying government bonds.

For the immediate future, however, things look about as rosy as they can be.

Christmas spending is shaping up to be strong. Low unemployment and the prospect of lower taxes should bolster wages and consumer spending next year. Household and corporate balance sheets look solid.

Barring any major shocks to the economy — such as rapidly higher interest rates or a trade war with China — most experts predict U.S. growth will perform above potential next year. It’s what happens after that which has some economists worried.

“We don’t see this as a sea change for the current economic cycle,” analysts at Morgan Stanley said Wednesday, referring to the tax bill.

“The fiscal impulse should fade and growth slow across the second half of 2019.”

[email protected]

Follow me at @dleelatimes

UPDATES:

9:55 a.m.: This article was updated with final passage of the tax bill.

This article was originally published at 9:05 a.m.