Sometimes, the outsiders have a clearer view of a situation than those who are in it. While many U.S. analysts hailed President Trump's tax reform as a boon for economic growth, European rating agency Scope Ratings is worried about its longer-term negative effect on debt and fiscal deficits.
It is not often that International Monetary Fund (IMF) growth projections, already usually quite prudent, are beaten to the downside by even more cautious ones from other organizations. Scope's growth forecasts for the U.S. achieve this "performance."
The IMF raised its growth forecast to 2.7% from 2.3% for this year and to 2.5% from 1.9% following the approval of Trump's tax cuts, saying that in the short term these will give a boost to the U.S. economy.
IMF Director Christine Lagarde did warn in Davos last month that the tax cuts risk destabilizing the American and global economies over the longer term, because they will push up debt and inflate asset prices further.
Scope Ratings analysts are even more pessimistic than the IMF. Their baseline scenario is that U.S. economic growth will be lower compared to the previous five years even with the tax cuts, averaging 1.9% between now and 2022. Their caution is based on three factors.
First, with the unemployment rate below 5% since 2016, the U.S. economy is "close to full employment," while core personal consumption expenditure, the Fed's favorite inflation gauge, was up 1.5% year on year in December. That is still below the Fed's declared 2% target, but the central bank is raising rates already to try to stay ahead of inflation.
"By adding to aggregate demand at this point in the cycle, the tax cuts could add to inflationary pressures and lead to faster-than-expected monetary policy tightening," the Scope Ratings analysts warned in a report published on Wednesday, Feb. 7.
Economic growth in the U.S. has averaged 2.2% since 2010. That's eight consecutive years of growth, one of the longest such periods, and "is unlikely to continue indefinitely."
The second reason why the tax cuts could not be the boon they are thought to be is the fact that U.S. companies already have more than $1.5 trillion in cash, which is more than enough for investing in equipment and workers before the tax cuts give them additional money.
So the rating agency does not expect American companies to launch into a spending spree following President Trump's reform. What company management might do with the extra cash is buy back shares and increase dividend distribution to shareholders. While good for stock markets, this does not necessarily boost economic growth.
Third, consumption in the U.S. is already at a high level, helped by cuts in the personal savings rate, which in December hit a 10-year low of 2.4%. Add to this the fact that not all households will benefit equally from the cuts, and their effect on consumption becomes even more unclear.
There are significant disparities by income groups, with higher income households likely to receive larger average tax cuts as a percentage of their after-tax income, the Scope Ratings report noted. These consumers are more likely than poorer ones to try to rebuild their savings rather than spend all their windfall.
Because of these three main reasons, the ratings agency expects the U.S. debt level to increase to 115% of GDP, from almost 104% currently. The American economy would have to expand very fast in order to avoid that.