Every semester, I reveal to a new class of students the marvels hidden in the mundane everyday exchanges that make life in a free society possible.
Students discover the causal relationships among the markets for labor, goods, services, banking, and international trade, and how those markets react to interventions by Congress (fiscal policy) and the Federal Reserve System (monetary policy).
Students apply economic principles — the words of Adam Smith, Friedrich Hayek, and Milton Friedman — to models with the assumption of ceteris paribus, or “all other things held constant.” These thought experiments are practice for reasoning through the consequences of real world changes in economic policy.
But ceteris ain’t always paribus. We now have the chance to observe the impact of a major economic policy shift. Recent implementation of the Tax Cuts and Jobs Act — legislation that alters the U.S. tax code — has given my students, our lawmakers, and American taxpayers an opportunity to experience the consequences of policy change firsthand.
The Tax Cuts and Jobs Act reduces the federal tax burden on corporations, small businesses, and individuals through a series of tax rate cuts and the creation of various tax deductions, but it fails to match those revenue cuts with cuts in spending. This tax bill is an example of expansionary fiscal policy.
In classroom exercises, we find that lower tax rates increase opportunities to exchange. Businesses and individuals keep more of the wealth they create to spend how they see fit. Households increase savings, giving, and spending. Businesses invest in new technologies and expand existing enterprises. Markets expand and available resources flow toward uses preferred by the people who constitute the economy. Economic growth accelerates and many enjoy a better standard of living.
Many businesses appear to be reinvesting the money that would have been taken, but for the tax cuts, by hiring more people, raising wages, giving out bonuses, and expanding employee benefits. Americans for Tax Reform reports that more than 400 U.S. companies have responded to the tax relief package by rewarding employees. Furthermore, changes to standards on government withholding allow people to keep more of their paycheck each month.
These macroeconomic indicators are consistent with a strong and growing economy. According to the Bureau of Labor Statistics, the unemployment rate is at its lowest level since 2000, and job creation remains robust. The rising labor force participation rate, along with increased economic investment from the private sector, could lead to GDP growth of three percent in 2018 — a major improvement from just two years ago when the growth rate was just half that.
The Tax Cuts and Jobs Act has only been in effect for a couple months now, so these impacts may be temporary. Early indicators suggest that the tax relief package is helping the U.S. economy, but unless spending is brought under control to match the federal cuts in revenue, these benefits may be short-lived. Nobel Laureate James Buchanan and co-author Richard Wagner taught us that “democracy in deficit” is often just a tool of politicians to please today’s voters at the expense of tomorrow’s.
