Financing a fiscal stimulus
In this scenario, measures of fiscal stimulus are expected to mainly take the form of infrastructure investments and tax cuts. The election programme of President Trump targeted both privately and publicly funded infrastructure investments in the amount of USD 1,000 billion over the next decade. In addition, the new administration also plans to relax both household and corporate taxes by roughly USD 5,000 billion over the same period.
Furthermore, the new budget proposal contains an increase in defence spending by USD 54 billion annually, to be financed by savings in other public expenditure. According to the Congressional Budget Office, the bill for an American Health Care Act recently introduced by the Republican administration would reduce federal expenditure by USD 337 billion over the coming decade.
According to some proposalsProposal of the House of Representatives (Ryan – Brady), see https://waysandmeans.house.gov/taxreform/., the rise in public spending caused by the fiscal stimulus will be funded by the introduction of a border adjustment tax, which would levy a corporate tax of e.g. 20% on US imports, while US exports would be exempt from tax, i.e. US export companies would be paid production subsidies in the amount of e.g. roughly 20%. The border adjustment tax is estimated to raise revenue in the amount of USD 1,000 billion over the next decadeThe GDP ratios of US exports and imports are 12% and 15%, respectively, which means that the additional revenue raised by the border adjustment tax would amount to 0.2x0.15-0.2x0.12, or around 0.6% of GDP..
Table 1 shows the effects of these pending economic policy measures on federal revenue and expenditure, assuming that infrastructure investments are publicly funded.
|Policy objectives of the new US administration for the next decade, USD 1,000 billion|
|Border adjustment tax||1||Infrastructure investments||1|
|Public expenditure savings||0.54||Defence spending||0.54|
|American Health Care Act||0.34||Tax reform||5|
|Source: Bank of Finland calculations.|
Policy package would spur growth in immediate years ahead
The effects of US economic policy plans can be analysed using a general equilibrium modelKortelainen (2013) Global Integrated Monetary and Fiscal Model, Bank of Finland Bulletin 1/2013. developed by the IMF (Table 2). Taken together, the measures analysed have a significant upward effect on growth. Fiscal stimulus measures financed by the border adjustment tax pull the pace of economic growth up by a full ½ of a percentage point per annum during the first three years.
In the scenario, the Federal Reserve responds by raising its policy rate by more than 1½ of a percentage point, prompting a major appreciation of the nominal trade-weighted exchange rate, by roughly 22%. Notwithstanding this, inflation will pick up by close to a percentage point before gradually moderating.
According to the scenario, private consumption will decline in response to the rise in import prices due to the border adjustment tax. Investments will grow mainly through a reduction in the corporate tax rate. This economic policy package will not improve the external balance of the US economy, given that the current account deficit will grow wider as imports are boosted by the fiscal stimulus. Nor will the economic policy under review generate any substantial savings in expenditure and, consequently, will not resolve the issue of how to maintain fiscal sustainability in the longer term.
|Effects of economic policy of new administration on the US economy: deviations from baseline|
|Over 3 years, on average|
|GDP||%, level deviation||2.1|
|Consumption||%, level deviation||–2.4|
|Investment||%, level deviation||10.3|
|Consumer price inflation||% points||0.9|
|Policy rate||% points||1.7|
|Current account/GDP||% points||–1.0|
|Nominal effective exchange rate||%, (–) is appreciation||–21.9|
|Source: Bank of Finland calculations.|
The amount, timing and particulars of fiscal stimulus are surrounded by major uncertainties. Taken together, the measures analysed here have a significant upward effect on growth. However, such an economic policy approach is associated with a considerable risk of increasing protectionism at the global level.
The introduction of a border adjustment tax could trigger instant trade counter measures in other countries. The realisation of these risks could have adverse consequences for the international economy, gradually rolling back the upward growth effects on the US economy.