No, Q3-2017 3% GDP growth does not support Big Tax Cuts!

The Washington Post recently published an article titled Third quarter's strong economic growth could boost GOP tax effort. The article predicts the Trump administration will make the case that if you want economic growth to keep increasing to 4% (President Trump's goal), we need tax cuts. The Financial Forecast Center (here) predicts GDP Growth Rates out to the end of 2017 (graphic above). The forecast graph does not even have room for 3%, let alone 4%, GDP growth this year. Who is right?

The GOP tax cut plan is based on a long chain of reasoning. Tax cuts are supposed to increase investment and consumption (I = iY - T and C = cY - T). Investment and consumption are supposed to increase National income (as does Government expenditure and the Balance of Payments, Y = I + C + G + BOP). On the other hand, tax cuts increase the deficit D = G - T which is supposed to crowd out investment through the interest rate effect (increased interest rates discourage borrowing). Any one of these effects could fail to materialized or provide only a short term boost to the economy when the Deficit chickens come home to roost.

Let's ask a more systemic question: What kind of growth rate is the US economy capable of sustaining? Another way to state the question is to ask what is the attractor path for GDP growth? The  attractor path for the annualized growth of US GDP (based on quarterly data, here) is displayed above. Out to 2030, the attractor path (the dashed red line based on the state of the US economy from the USL20 model*) is stable at around 2%. The 98% bootstrap prediction intervals (the dashed green and blue lines) suggest that numbers from 1.5% to 2.5% are probable. Growth rates above 3.5% or even negative are possible but the economy will return over time to around 2%. This is the growth rate that the US Economy can reasonably sustain given the current physical structure and economic organization. 

The real growth of the US economy, Q = f(K,L,Tech), is based on how capital, labor and technology are combined. Changes in who has money may or may not make a difference to the physical structure and economic organization of the US economy. The excess money available from tax cuts (especially if directed at the wealthy) can be spent on luxury goods or stock market speculation, neither of which will build economic capacity through investment and employment. 

If the fractured GOP is able to legislate tax cuts, time will tell how the US economy is affected. The most likely prediction is that high growth rates, if they happen at all, would be very temporary.

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* The best model (determined by the AIC criterion) is ag(GDPQ)(t) =  (F)ag(GDPQ)(t-1) + G(S)(t-1) + Qe(t), where ag() is annualized growth, F, G and Q are coefficient matrices, S is the state vector from the USL20 model and e(t) is random error. The current upsurge in US GDPQ is driven by e(t).