On Nov. 16, House Republicans passed important tax reform legislation to simplify the tax code from seven brackets to four, roughly doubling the standard deduction, closing many tax loopholes and deductions for special interests, and substantially lowering taxes for small businesses and corporations.
Whether or not these policies will benefit most Americans, one thing is abundantly clear: If Congress fails to pass a pro-business tax reform plan, and many analysts believe that’s a real possibility because of the Republicans’ tight margin in the Senate, an economic crash is very likely to occur.
Since the Republicans’ victories last fall, investors, consumers and business leaders have been operating under the assumption the new Congress and White House would lower regulations and significantly reduce taxes, causing notable economic and investment growth. Businesses and investors have been ramping up their activities, based on the expectation that lower corporate and individual tax rates will leave them with a larger share of the profits they make, thus providing them with more money to invest.
That explains much of the gains experienced in recent months in the stock market. In October 2016, just one month before the election, the Dow Jones Industrial Average (DIJA) was 18,432. The monthly average for October 2017 was 23,377, a 26 percent increase, making this one of the quickest booms for DJIA in U.S. history.
Much of the increase came during the months of November through January — before the new Congress and Trump administration had the opportunity to pass any policies affecting the economy and long before they released their current, detailed tax reform plan. The increases weren’t driven by actual policy changes but by expectations of change.
The effect of those rosy expectations is also evident in the dramatic rise of consumer confidence experienced since Trump’s election night victory. The University of Michigan’s “consumer sentiment” score has risen more than 9 percent since October 2016, and the current three-month average is among the highest since 2000. If this confidence quickly reverses and people stop buying, businesses will be forced to cut back, strangling the infant recovery.
The president has already delivered on one of the promises, making several important moves to reduce federal government regulations. A recent study by the National Association of Manufacturers found federal regulations cost the economy $2.02 trillion per year.
These regulation cutbacks have undoubtedly contributed to the economic growth to date, but businesses, investors and consumers have been making virtually all their decisions with expected tax relief also in mind. Pulling the rug out from under them would likely result in a cascading series of investment corrections that could kill jobs and productivity.
Ordinarily, a Congress and administration might be given significant time to work through the complexities of a tax reform plan before investors, consumers and businesses begin to worry, but faith in this Congress has eroded substantially in recent months, thanks in large part to its failure to replace Obamacare. Congress’ approval rating is now at one of its lowest points since Trump’s inauguration.
Congressional Republicans must pass tax reform. If they don’t, the economy, as well as their party’s 2018 election hopes, is likely to suffer.
Justin Haskins is executive editor and a research fellow at The Heartland Institute. S. T. Karnick is publications director and a research fellow there.