Trigger Warning: How a Tax Measure Could Worsen the Next Recession

By Nick Timiraos and Kate Davidson

Sen. James Lankford (R., Okla.) has said lawmakers would design the trigger so they can turn it off during a recession.
Sen. James Lankford (R., Okla.) has said lawmakers would design the trigger so they can turn it off during a recession. Photo: Andrew Harrer/Bloomberg                                

The Senate Republican tax plan making its way toward a vote today could include a poison pill that worsens a recession somewhere down the road: a so-called trigger that reverses tax cuts or imposes spending cuts if federal revenues come in lower than expected.

Though the details of the provision haven’t been laid out, Republican lawmakers have agreed in principle to such a provision as a way to address worries that tax cuts now might lead to revenue losses and deficit increases in the years to come. The trigger would partially reverse some tax cuts if revenues come in below expectations.

The problem is what happens in an economic downturn. Revenues tend to go down in a recession because business and household income declines, reducing taxable income. A trigger could impose tax hikes or spending cuts on the economy at a moment when it is already weak, a step that economists say might worsen the next recession.

Real gross domestic product, change from a year earlier, by selected sector

Traditionally, Congress has responded to downturns by doing the opposite — cutting taxes or boosting spending, following the model of British economist John Maynard Keynes, who proposed aggressive government spending to battle the Great Depression.

“No recession is on the horizon, but another recession hitting while a trigger was in place would create enormous problems,” J.D. Foster, chief economist at the U.S. Chamber of Commerce, wrote in a blog post.

If the trigger is activated when the next recession hits, that would raise taxes “and therefore acts as a further drag on GDP growth just as the economy is going south,” said Ernie Tedeschi, an economist at Evercore ISI, an investment research firm, who previously worked in the Treasury Department during the Obama administration.

Economists call such a policy “pro-cyclical,” meaning it exaggerates the ups and downs of a business cycle, adding fuel to growth when times are good and taking away the fuel when times are bad.

It would be similar to what many states, facing requirements to balance their budgets, have to do during downturns. State and local government spending contracted for four straight years between 2010 and 2013 – the longest run of cuts in the post-World War II era — slowing the national economic recovery and aggravating an already tepid expansion.

“They had big revenue shortfalls coming from the recession and then they had to fire state workers, cut spending, raise taxes—all the kinds of things that make no sense in a recession,” said Alan Auerbach, a professor of economics and law at the University of California at Berkeley. The federal government doesn’t have such a requirement. Imposing one “would be really unfortunate,” Mr. Auberach said.

Other types of automatic triggers have been used before to smooth the passage of major fiscal legislation, with mixed effects on the economy and budgets.

In 2011 the Obama administration and Republican leaders in Congress agreed to a series of automatic spending curbs to address worries about larger deficits that followed the financial crisis. One package of such cuts, known as sequestration, would kick in only if a bipartisan committee did not agree on a plan to reduce deficits. Congress failed to agree on a deficit-reducing package, and the across-the-board cuts eventually took hold in 2013, slowing the expansion, but also holding down deficits. Federal spending contracted for five straight years between 2011 and 2015. Deficits as a percent of gross domestic product shrank from 8.5% in 2011 to 2.4% in 2015.

Senate Republicans haven’t specified how their trigger would work and the design could have big implications.

Mr. Tedeschi said Congress could mitigate the problem known as “pro cyclicality” by basing the trigger on longer-run changes in government revenues that aren’t set off by short-term economic swings. Sen. James Lankford (R., Okla.), a proponent of the trigger, said lawmakers would design it so they can turn it off during a recession.

Mr. Lankford said concerns about a pending recession soon after a large tax cut are unfounded, “but we’re are building in language to make sure we’re protecting it either way.”

“You don’t want to have a situation where you’re in a recession and taxes go up,” he said in an interview Wednesday on “CBS This Morning.” “And we’re not talking about a large tax increase. We’re talking about small things around the edges to be able to guard against future increases in deficits. So both of those can be done.”

Attempts to control for the business cycle would be difficult, Mr. Auerbach said, because policy makers would not necessarily know how deep a recession might be or how long it would last, given that such information comes with a lag and is often revised. Often the economy is in a recession for several months before one is even officially declared. For instance, the U.S. economy last fell into a recession in December 2007, which researchers officially announced in December 2008.

“Talking about a trigger as if it could really provide an effective protection for the revenue loss, it’s not an effective policy,” Mr. Auerbach said. “It’s bad economic policy.”

Republicans project that tax cuts will spur economic growth and help to boost federal revenue even as tax rates come down. These debt sustainability worries exist in part because past tax cuts haven’t always lived up to expectations of higher revenues, forcing legislatures to reverse them later. Congress forced President Ronald Reagan in 1982 to repeal some of the 1981 tax cuts, and Kansas recently undid its business-tax cuts after they led to big revenue losses.

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