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Financial Planning > Tax Planning > Tax Deductions

House, Senate Tax Bills Will Not Help Economy: Moody’s

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Proponents of the House and Senate Republican tax cut bills argue that the cuts will energize the U.S. economy, increasing GDP by at least 2% to 3% annually, but Moody’s Analytics says neither plan “would meaningfully improve economic growth, at least not on a sustained basis.”

The reason: Since the economy is operating at full employment, the fiscal stimulus from the tax cuts would result in stronger inflation and higher interest rates, which would erase the benefit of lower corporate tax rates, targeted to drop from 35% to 20%. That would leave the economy “no bigger than it would have been without the tax cuts,” according to Moody’s.

The House plan would increase annual GDP growth from 2% to 2.03% over the next decade, Moody’s analysts write.  

The analysts base their conclusions on the following: The tax cuts would increase GDP growth by 30 basis points, or 0.30%, in 2018, adding half a million jobs and pushing unemployment below 4%. Since that’s below the 4.5% rate that the Fed believes is consistent with stable inflation, the Fed will respond by raising short-term rates more aggressively. Long-term rates would also increase because of expectations of bigger budget deficits.

The analysts are slightly more optimistic about the economic benefits of the Senate plan, which delays the corporate tax cut until 2019. They forecast an annual 10 basis-point increase in GDP growth in 2018 and 2019 but only a 4 basis point annually overall for the next decade.

In addition to having little impact on economic growth, both the House and Senate tax plans would “significantly exacerbate the nation’s fiscal problems,” according to Moody’s. The plans would add roughly $1.5 trillion to the deficit over 10 years, driving the debt-to-GDP ratio up from 75% currently to 100% a decade from now.

The debt-to-GDP ratio is expected to rise to 95% in 10 years even if there were no change in tax policy but that still doesn’t justify the tax cuts because any increase in the debt load is “bad policy,” according to Moody’s.

The analysis also finds that housing prices will decline as a result of the tax cuts because of changes to state and local property tax deductions (the Senate plan eliminates the deduction; the House plan limits it to $10,000) and the reduced value of the mortgage interest deduction (the House limits it to mortgages at or below $500,000 and the Senate sets the cap at $1 million, but both plans double the standard deduction, which will reduce the number of taxpayers who itemize their deductions). In addition, higher interest rates would reduce the demand for housing.

“The hit to national house prices is estimated to be as much as 5%,” with an even greater impact on higher priced homes, according to Moody’s.

In contrast, stock prices could rise by 10% to 15% over 10 years as result of the tax cuts, although some of that increase may have already occurred because of expectations for tax reform.

One big uncertainty of the proposed tax cut plans is the sunset provision after 10 years. Senate rules require a 10-year budget horizon if the bill is to be passed under the reconciliation process, which requires a simple majority vote, and is the plan among Senate Republicans.

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