Fuel for the fire

Will federal tax cut spark greater economic growth?

The long-running expansion of the U.S. economy that began in 2009 continued in 2017.

Second and third quarter growth in U.S. gross domestic product exceeded 3 percent, a quarterly growth level that hadn’t been achieved since the first quarter of 2015.

The U.S. unemployment rate continued a steady decline from 4.8 percent in January to 4.1 percent in November. The low unemployment rate shows the strength of the U.S. labor market, but also demonstrates why many businesses are having a hard time finding employees, which hurts their ability to grow.

The low unemployment rate could also be dampening job growth. It’s hard to create jobs without people to fill them. Despite the economic growth of 2017, U.S. job growth for the year was down compared to 2016. From January through November the U.S. economy created 1,916,000 jobs, compared to 2,085,000 jobs created during the same time period in 2016, according to the U.S. Bureau of Labor Statistics.

A year ago, many wondered how President Donald Trump’s policies would impact the economy. He has not been shy about calling attention to its performance last year. In December, Trump tweeted, “Things are going really well for our economy, a subject the Fake News spends as little time as possible discussing! Stock Market hit another RECORD HIGH, unemployment is now at a 17 year low and companies are coming back into the USA. Really good news, and much more to come!”

For most of 2017, Trump and the Republican-controlled Congress had few major legislative accomplishments to boost the economy. But Trump was able to roll back numerous regulations, a pro-business approach that helped inspire optimism for American companies. Meanwhile, investor optimism was seen in the performance of the U.S. stock market in 2017, as the Dow Jones Industrial Average rose by 25 percent during the year. The S&P 500 increased 19 percent and the Nasdaq was up 28 percent on the year.

Then, at the end of 2017, Trump and the Republicans pushed through a $1.5 trillion tax cut, which includes a significant reduction in the U.S. corporate tax rate from 35 percent to 21 percent. In another tweet, Trump said the tax cut will spur more economic growth in 2018: “All signs are that business is looking really good for next year, only to be helped further by our Tax Cut Bill. Will be a great year for Companies and JOBS! Stock Market is poised for another year of SUCCESS!”

Business leaders are hopeful that the federal tax cut will indeed spur more significant economic growth in 2018. In a survey of Wisconsin business leaders by Wisconsin Manufacturers & Commerce, 77 percent said they either “strongly” or “somewhat” supported the federal tax reform package.

Michael Knetter, a former staff economist for presidents George H.W. Bush and Bill Clinton, said the federal tax cut will be a major theme for the performance of the U.S. economy in 2018.

“It’s really a question of whether new demand caused by the tax cut can call forth increased supply or whether it will simply boost prices because we are (already) near full employment,” said Knetter, who once again provided the macroeconomic outlook at BizTimes Media’s annual Northern Trust Economic Trends Breakfast on Jan. 19. “(The tax cut) will be stimulative in the near term, and the long-term effects are more uncertain. If it expands supply, the cut could pay for itself, but I am skeptical. Of course, so many other things will change in the economy, we will never know for sure. I think the reduction in corporate taxation makes good sense. That is the part of the bill that I believe is truly helpful. It makes it easier for companies to locate here and be competitive. The rest of the bill seemed like a missed opportunity to simplify the code.”

To seek more insight on what lies ahead for the U.S. economy in 2018, BizTimes Milwaukee editor Andrew Weiland conducted his annual macroeconomic interview with Knetter, the president and chief executive officer of the University of Wisconsin Foundation. The following are excerpts from that interview:

BIZTIMES: The U.S. economy appears to be picking up steam. U.S. GDP grew more than 3 percent for the second and third quarters. Why has the economy gained momentum? Do you expect it to continue to grow at 3-plus percent next year?

Knetter

KNETTER: “This has been a broad expansion as economies around the globe finally seem to be growing simultaneously. It has been a long, slow recovery, but that is not unusual in the wake of a financial crisis as firms and households behave cautiously and rebuild their balance sheets in the early phase of the upturn. That slow gathering of momentum is what many economists predicted coming out of the financial crisis. The U.S. tax cut will help sustain corporate earnings and thus the stock market, which bodes well for consumption in 2018. I expect the economy to continue to expand, although the tight labor market will constrain growth and may put upward pressure on prices.”

BIZTIMES: The U.S. unemployment rate is now at 4.1 percent. How much lower will it go? 

KNETTER: “It may tick down below 4 percent, depending on how participation evolves.”

BIZTIMES: With unemployment so low, we hear from a lot of business leaders who say they are struggling to find workers. Any ideas for how to address that challenge? Could a more open immigration policy help here?

KNETTER: “Immigration is the fastest way to grow the workforce beyond what domestic demographic patterns imply. Obviously, it takes about 25 years to grow a new domestic worker if you start now! So any near term expansion of the labor force requires higher participation rates (people who left the workforce these last few years return to look for a job) or bringing new workers into the country.”

BIZTIMES: Despite the low unemployment rate and the shortage of workers, wages in the U.S. continue to grow sluggishly. Why is that? Do you expect wage growth to pick up in 2018?

KNETTER: “Low-skilled workers are still competing with technology, which will hold back wage growth in many occupations. I think labor costs will rise and incomes will rise more for white collar than blue collar workers.”

BIZTIMES:The Fed recently raised interest rates for the fifth time since the Great Recession. Should we expect more rate increases in 2018? What impact will these moves have on the economy?

KNETTER: “I think the Fed is best viewed as following, and not leading, the economy. I expect the Fed will keep moving rates up as long as the economy seems able to advance. Three hikes this year seems plausible given the momentum in the economy and the tax cut.”

BIZTIMES: What impact will the federal tax cut have on the economy?

KNETTER: “The magnitude of the tax cut is estimated to be about $1.5 trillion over a decade. The cut is expected to have a modest positive impact on growth, which means the net impact on the national debt over a decade is a $1 trillion increase (i.e., $500 billion in new revenues will come from the additional economic growth). It is estimated that 80 percent of filers will have lower taxes, 15 percent will be about the same, and 5 percent will see taxes go up.

“The corporate rate falls from 35 percent to 21 percent, while the top individual rates drop from 39.6 percent to 37 percent. The individual rate cut ends in 2025, while the corporate cuts are permanent. The goal of lower corporate taxes is to encourage more companies to remain in or move to the U.S. The ultimate incidence of the corporate cut is unclear. The degree to which it will increase profits and the return to capital, decrease prices or increase wages is a matter of debate.

“The number of moving parts in the tax bill make it difficult to give a definitive up or down on the whole bill. It really depends on your goals and core beliefs about efficiency versus equity. I tend to believe that the provisions that simplify the code and reduce corporate taxes are positive features. The individual rate cut probably has little stimulative effect and has the biggest impact on growing the deficit.”

BIZTIMES: What is the best- and worse-case impact of the tax cut, especially on the economy but also on federal programs and the deficit?

KNETTER: “The worst case impact would be realized if interest rates begin to rise and the debt service costs grow dramatically. The best case would be if the tax cut enables a continuation of the expansion for several more years. I am concerned that the worst case scenario has a higher likelihood of being realized.”

BIZTIMES: The stock market is at a record high. What is your outlook for equities in 2018?

KNETTER: “Earnings continue to look good given the momentum in the economy and the corporate tax cut. Equities could continue to run higher for another year barring a negative catalyst. I would expect a normal year, maybe plus 6 to 8 percent in public equities.”

BIZTIMES: What inning is the U.S. economy in?

KNETTER: “An extra one. Or two! It’s a long expansion by historical standards.”

BIZTIMES: Should we all invest in Bitcoin? Or are we too late?

KNETTER: “We should all change our names to Blockchain and IPO ourselves! The idea of a cryptocurrency whose supply is not tied to a government or national monetary authority has some merit. Fiat currencies (currencies not backed by hard assets) are a relatively new phenomenon and most of them lose value. So for many people around the world, this could be quite attractive. A cryptocurrency only becomes useful and valuable if many other people are using it. It seems likely one cryptocurrency will eventually prevail but I am not sure that is Bitcoin. The supply side of Bitcoin seems mysterious to most people.”

BIZTIMES: Will health care reform make a comeback in 2018, or is it dead?

KNETTER: “It looks like it’s in the penalty box. I can’t tell if it’s a major or a minor penalty, but I doubt Congress could pass anything on health care given how hard it was to cut taxes.”

BIZTIMES: President Trump talked tough on trade this year. Was any progress made there? What direction is the U.S. going with its trade policy?

KNETTER: “So far, trade and the wall have been vehicles for cathartic trash talking, which can be both entertaining and hurtful. Whether the rhetoric turns into any real policy thrust remains to be seen. I hope nothing gets done on this front.”

BIZTIMES: When is the next recession looming?

KNETTER: “If I knew, I would be spending my future fortune and keeping the details to myself. It’s looming now but the economy could keep growing if we don’t have a negative catalyst. There has been fairly balanced global growth this past year or two and earnings of companies are holding up well. That means nothing appears to be broken in terms of the growth path. It is possible the tax cut will be somewhat disruptive in that sense, pushing the economy further than a fully employed labor force can handle and creating some inflationary pressure. It is possible the tax cut now is like opening one more bottle at a party that has gone on too long already… Time will tell.”

BIZTIMES: Wisconsin is betting heavily on Foxconn to become an economic anchor. Is that a good bet? How do you think the Foxconn deal will play out for the state?

KNETTER: “Foxconn is a serious company with over 1 million employees worldwide. That speaks to the volume of work they do and you just don’t get that volume of work without delivering good products at good prices. It’s a competitive world and they are clearly competing well.

“There have been complaints about labor practices in China, including much-publicized suicides by workers there. A deeper dive shows that some of this is related to the sheer scale of their employee base in China and work practices that are not to Western standards. Their largest complex is called Foxconn City and it was reported to have 300,000 employees. That is clearly a different operation.

“Foxconn has production facilities around the globe but very little production taking place in advanced Western countries. That makes it hard to predict how this new venture will unfold. It is uncharted territory for both parties. I am convinced that Foxconn knows how to satisfy customers or they would not be where they are. And Wisconsin has a great workforce at many levels. But it is not obvious this is a great fit given the limited experience Foxconn has in the West. In the end, it will be what both parties choose to make of it and we should hope that it works well and that it helps Wisconsin gain a bigger toehold in the knowledge economy space.”

The long-running expansion of the U.S. economy that began in 2009 continued in 2017.

Second and third quarter growth in U.S. gross domestic product exceeded 3 percent, a quarterly growth level that hadn’t been achieved since the first quarter of 2015.

The U.S. unemployment rate continued a steady decline from 4.8 percent in January to 4.1 percent in November. The low unemployment rate shows the strength of the U.S. labor market, but also demonstrates why many businesses are having a hard time finding employees, which hurts their ability to grow.

The low unemployment rate could also be dampening job growth. It’s hard to create jobs without people to fill them. Despite the economic growth of 2017, U.S. job growth for the year was down compared to 2016. From January through November the U.S. economy created 1,916,000 jobs, compared to 2,085,000 jobs created during the same time period in 2016, according to the U.S. Bureau of Labor Statistics.

A year ago, many wondered how President Donald Trump’s policies would impact the economy. He has not been shy about calling attention to its performance last year. In December, Trump tweeted, “Things are going really well for our economy, a subject the Fake News spends as little time as possible discussing! Stock Market hit another RECORD HIGH, unemployment is now at a 17 year low and companies are coming back into the USA. Really good news, and much more to come!”

For most of 2017, Trump and the Republican-controlled Congress had few major legislative accomplishments to boost the economy. But Trump was able to roll back numerous regulations, a pro-business approach that helped inspire optimism for American companies. Meanwhile, investor optimism was seen in the performance of the U.S. stock market in 2017, as the Dow Jones Industrial Average rose by 25 percent during the year. The S&P 500 increased 19 percent and the Nasdaq was up 28 percent on the year.

Then, at the end of 2017, Trump and the Republicans pushed through a $1.5 trillion tax cut, which includes a significant reduction in the U.S. corporate tax rate from 35 percent to 21 percent. In another tweet, Trump said the tax cut will spur more economic growth in 2018: “All signs are that business is looking really good for next year, only to be helped further by our Tax Cut Bill. Will be a great year for Companies and JOBS! Stock Market is poised for another year of SUCCESS!”

Business leaders are hopeful that the federal tax cut will indeed spur more significant economic growth in 2018. In a survey of Wisconsin business leaders by Wisconsin Manufacturers & Commerce, 77 percent said they either “strongly” or “somewhat” supported the federal tax reform package.

Michael Knetter, a former staff economist for presidents George H.W. Bush and Bill Clinton, said the federal tax cut will be a major theme for the performance of the U.S. economy in 2018.

“It’s really a question of whether new demand caused by the tax cut can call forth increased supply or whether it will simply boost prices because we are (already) near full employment,” said Knetter, who once again provided the macroeconomic outlook at BizTimes Media’s annual Northern Trust Economic Trends Breakfast on Jan. 19. “(The tax cut) will be stimulative in the near term, and the long-term effects are more uncertain. If it expands supply, the cut could pay for itself, but I am skeptical. Of course, so many other things will change in the economy, we will never know for sure. I think the reduction in corporate taxation makes good sense. That is the part of the bill that I believe is truly helpful. It makes it easier for companies to locate here and be competitive. The rest of the bill seemed like a missed opportunity to simplify the code.”

To seek more insight on what lies ahead for the U.S. economy in 2018, BizTimes Milwaukee editor Andrew Weiland conducted his annual macroeconomic interview with Knetter, the president and chief executive officer of the University of Wisconsin Foundation. The following are excerpts from that interview:

BIZTIMES: The U.S. economy appears to be picking up steam. U.S. GDP grew more than 3 percent for the second and third quarters. Why has the economy gained momentum? Do you expect it to continue to grow at 3-plus percent next year?

Knetter

KNETTER: “This has been a broad expansion as economies around the globe finally seem to be growing simultaneously. It has been a long, slow recovery, but that is not unusual in the wake of a financial crisis as firms and households behave cautiously and rebuild their balance sheets in the early phase of the upturn. That slow gathering of momentum is what many economists predicted coming out of the financial crisis. The U.S. tax cut will help sustain corporate earnings and thus the stock market, which bodes well for consumption in 2018. I expect the economy to continue to expand, although the tight labor market will constrain growth and may put upward pressure on prices.”

BIZTIMES: The U.S. unemployment rate is now at 4.1 percent. How much lower will it go? 

KNETTER: “It may tick down below 4 percent, depending on how participation evolves.”

BIZTIMES: With unemployment so low, we hear from a lot of business leaders who say they are struggling to find workers. Any ideas for how to address that challenge? Could a more open immigration policy help here?

KNETTER: “Immigration is the fastest way to grow the workforce beyond what domestic demographic patterns imply. Obviously, it takes about 25 years to grow a new domestic worker if you start now! So any near term expansion of the labor force requires higher participation rates (people who left the workforce these last few years return to look for a job) or bringing new workers into the country.”

BIZTIMES: Despite the low unemployment rate and the shortage of workers, wages in the U.S. continue to grow sluggishly. Why is that? Do you expect wage growth to pick up in 2018?

KNETTER: “Low-skilled workers are still competing with technology, which will hold back wage growth in many occupations. I think labor costs will rise and incomes will rise more for white collar than blue collar workers.”

BIZTIMES:The Fed recently raised interest rates for the fifth time since the Great Recession. Should we expect more rate increases in 2018? What impact will these moves have on the economy?

KNETTER: “I think the Fed is best viewed as following, and not leading, the economy. I expect the Fed will keep moving rates up as long as the economy seems able to advance. Three hikes this year seems plausible given the momentum in the economy and the tax cut.”

BIZTIMES: What impact will the federal tax cut have on the economy?

KNETTER: “The magnitude of the tax cut is estimated to be about $1.5 trillion over a decade. The cut is expected to have a modest positive impact on growth, which means the net impact on the national debt over a decade is a $1 trillion increase (i.e., $500 billion in new revenues will come from the additional economic growth). It is estimated that 80 percent of filers will have lower taxes, 15 percent will be about the same, and 5 percent will see taxes go up.

“The corporate rate falls from 35 percent to 21 percent, while the top individual rates drop from 39.6 percent to 37 percent. The individual rate cut ends in 2025, while the corporate cuts are permanent. The goal of lower corporate taxes is to encourage more companies to remain in or move to the U.S. The ultimate incidence of the corporate cut is unclear. The degree to which it will increase profits and the return to capital, decrease prices or increase wages is a matter of debate.

“The number of moving parts in the tax bill make it difficult to give a definitive up or down on the whole bill. It really depends on your goals and core beliefs about efficiency versus equity. I tend to believe that the provisions that simplify the code and reduce corporate taxes are positive features. The individual rate cut probably has little stimulative effect and has the biggest impact on growing the deficit.”

BIZTIMES: What is the best- and worse-case impact of the tax cut, especially on the economy but also on federal programs and the deficit?

KNETTER: “The worst case impact would be realized if interest rates begin to rise and the debt service costs grow dramatically. The best case would be if the tax cut enables a continuation of the expansion for several more years. I am concerned that the worst case scenario has a higher likelihood of being realized.”

BIZTIMES: The stock market is at a record high. What is your outlook for equities in 2018?

KNETTER: “Earnings continue to look good given the momentum in the economy and the corporate tax cut. Equities could continue to run higher for another year barring a negative catalyst. I would expect a normal year, maybe plus 6 to 8 percent in public equities.”

BIZTIMES: What inning is the U.S. economy in?

KNETTER: “An extra one. Or two! It’s a long expansion by historical standards.”

BIZTIMES: Should we all invest in Bitcoin? Or are we too late?

KNETTER: “We should all change our names to Blockchain and IPO ourselves! The idea of a cryptocurrency whose supply is not tied to a government or national monetary authority has some merit. Fiat currencies (currencies not backed by hard assets) are a relatively new phenomenon and most of them lose value. So for many people around the world, this could be quite attractive. A cryptocurrency only becomes useful and valuable if many other people are using it. It seems likely one cryptocurrency will eventually prevail but I am not sure that is Bitcoin. The supply side of Bitcoin seems mysterious to most people.”

BIZTIMES: Will health care reform make a comeback in 2018, or is it dead?

KNETTER: “It looks like it’s in the penalty box. I can’t tell if it’s a major or a minor penalty, but I doubt Congress could pass anything on health care given how hard it was to cut taxes.”

BIZTIMES: President Trump talked tough on trade this year. Was any progress made there? What direction is the U.S. going with its trade policy?

KNETTER: “So far, trade and the wall have been vehicles for cathartic trash talking, which can be both entertaining and hurtful. Whether the rhetoric turns into any real policy thrust remains to be seen. I hope nothing gets done on this front.”

BIZTIMES: When is the next recession looming?

KNETTER: “If I knew, I would be spending my future fortune and keeping the details to myself. It’s looming now but the economy could keep growing if we don’t have a negative catalyst. There has been fairly balanced global growth this past year or two and earnings of companies are holding up well. That means nothing appears to be broken in terms of the growth path. It is possible the tax cut will be somewhat disruptive in that sense, pushing the economy further than a fully employed labor force can handle and creating some inflationary pressure. It is possible the tax cut now is like opening one more bottle at a party that has gone on too long already… Time will tell.”

BIZTIMES: Wisconsin is betting heavily on Foxconn to become an economic anchor. Is that a good bet? How do you think the Foxconn deal will play out for the state?

KNETTER: “Foxconn is a serious company with over 1 million employees worldwide. That speaks to the volume of work they do and you just don’t get that volume of work without delivering good products at good prices. It’s a competitive world and they are clearly competing well.

“There have been complaints about labor practices in China, including much-publicized suicides by workers there. A deeper dive shows that some of this is related to the sheer scale of their employee base in China and work practices that are not to Western standards. Their largest complex is called Foxconn City and it was reported to have 300,000 employees. That is clearly a different operation.

“Foxconn has production facilities around the globe but very little production taking place in advanced Western countries. That makes it hard to predict how this new venture will unfold. It is uncharted territory for both parties. I am convinced that Foxconn knows how to satisfy customers or they would not be where they are. And Wisconsin has a great workforce at many levels. But it is not obvious this is a great fit given the limited experience Foxconn has in the West. In the end, it will be what both parties choose to make of it and we should hope that it works well and that it helps Wisconsin gain a bigger toehold in the knowledge economy space.”

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