Three Percent GDP Growth and Democrats’ Irresponsible Opposition to Trump Tax Cuts

The Democrats were virtually unanimous in opposition to the tax cuts that Republicans pushed through Congress last year. They had good cause. The overwhelming majority of the tax cuts go to the richest 1 percent of the population, the same group that has gotten the bulk of the gains from economic growth over the last four decades. For those who don’t think making the rich richer is an important priority of government, the tax cuts were a really bad idea.

However, many of the Democratic criticisms of the tax cuts were off base. First, all the screaming about the budget deficit was disconnected from reality. Given that inflation is still running well below the Federal Reserve’s 2 percent target, and interest rates remain very low by historical standards, the claim that the deficits created by the tax cuts would be disastrous has no grounding in reality.

But even worse than the complaints about the tax cuts was the scorn that many leading Democratic economists directed toward the Republican claim that the economy could sustain a 3 percent rate of GDP growth. While there is little reason to believe that the tax cuts would lead to the sort of boost in growth claimed by proponents, it is actually very plausible that GDP growth could average 3 percent over the next decade.

There are two factors that determine GDP growth: the rate of growth of the labor force and the rate of growth of productivity. The rate of labor force growth is almost certain to be slower going forward simply because the massive baby boom cohort will be retiring over the next decade.

This demographic fact, combined with the end of the surge of women entering the labor force, means that labor force growth is likely to be less than 1 percent annually, compared to rates of close to 2 percent in prior decades. There is some room for additional growth as people who left the labor market may reenter, if a tighter labor market creates more job opportunities. But even a 3 percentage point rise in participation rates only boosts growth by 0.3 percentage points annually. That may get us to 0.7 or 0.8 percent annual growth, but certainly not to the rates we saw in the 1970s and 1980s.

If we can be reasonably certain about the pace at which the labor force will grow, the same is not true of productivity. The reality is that economists have been incredibly bad at predicting productivity growth.

We had a long period of 3 percent annual productivity growth from 1947 to 1973. Growth then slowed to less than 1.5 percent annually over the period from 1973 to 1995. This slowdown was completely unforeseen and there is still no universally accepted explanation for its cause.

Productivity growth then surged back to a 3 percent annual rate in the decade from 1995 to 2005. It unexpectedly fell back to just over 1 percent in the period since 2005. This drop was not expected at the time and is not well understood.

Given this history, it is rather bizarre that many of the most prominent economists associated with the Democratic Party dismiss the idea that productivity might again rise above a 2 percent annual rate. The track record of the economics profession doesn’t provide much basis for their confidence.

This matters hugely because there is some reason to believe that productivity is picking up for reasons having nothing to do with the tax cut. Productivity growth averaged 2.1 percent in the second and third quarter of last year. It then fell slightly in the fourth quarter due to quirks in the data, specifically a surge in the number of people reported as self-employed. But with early reports indicating first quarter GDP growth will be well over 3 percent, we are likely to see another quarter of strong productivity growth.

While this uptick cannot be plausibly explained by the tax cut, there is an alternative explanation: It may simply be the result of a tighter labor market. The tighter labor market has led to increased wage growth at the bottom end of the pay ladder.

A tight labor market has two effects. First, as employers have to pay more for labor, the least productive jobs will go unfilled. Think of greeters at Walmart. If the store has to pay $15 an hour for its workers, it will likely have many fewer greeters. If we eliminate the least productive jobs, average productivity rises.

The second reason productivity growth could increase is that employers will have more incentive to think about ways they can get by with fewer workers. This could mean they will replace cashiers with automated checkout counters or make other such labor saving changes.

It’s worth noting that the “robots-taking-the-jobs” crew are staunch proponents of the high productivity growth view even if they may not realize it. Anyone who thinks there will be massive job displacement due to technology in the near future agrees with the Republicans about the economy’s growth prospects.

This all matters from a political standpoint because it would be unfortunate if the Republicans were to get credit for a pickup in growth which has nothing to do with them. Some of us did try to warn of this possibility last year, but the leading Democratic economists were not interested in our assessment.

Just to repeat what we said then, it is very possible that we will see something like the 3 percent GDP growth promised by the Republicans, but not because we gave more money to rich people. Because so many denied this possibility, Democratic economists may end up helping to convince people that giving money to the rich is the key to a strong economy.