Tax Law May Stimulate Economy Less Than Expected, Or Maybe Not At All, S.F. Fed Economists Say

Citing a bevy of recent research, economists Tim Mahedy and Daniel J. Wilson said fiscal stimulus measures tend to make a bigger splash when there is more slack in the economy.

“The projected procyclical policy over the next few years may raise concerns regarding the nation’s fiscal capacity to respond to future downturns and its ability to manage the growing federal debt,” Messrs. Mahedy and Wilson wrote in an economic letter posted on the San Francisco Fed’s website. “However, it also has important implications for the macroeconomic impact of the fiscal stimulus represented by the [tax law] and the consequent increase in the deficit.”

Among the research Messrs. Mahedy and Wilson cited were estimates of the so-called fiscal multiplier, or the response of gross domestic product to changes in tax and spending policy. While some of the research found there was merely a larger impact from stimulus measures during recessions than during expansions, other “literature on fiscal spending multipliers suggests an even smaller boost, as low as zero.”

The conclusions provided fodder for Democrats’ harsh criticism of the tax law.

Senate Democratic Leader Chuck Schumer of New York seized on that line of the report, tweeting, “Once again, we see the tax bill @realDonaldTrump & the GOP pitched to the American people was actually a #GOPTaxScam for the rich.”

Republicans contend that the lower corporate tax rate and other changes will spur investment, enhance productivity and raise the economy’s long-term potential for growth.

Messrs. Mahedy and Wilson’s findings run counter to many economists’ predictions the tax law—projected to add about 16%, or $1.6 trillion, to the federal deficit between 2018 and 2027—will provide a meaningful short-term lift to the economy.

In its latest economic outlook, published in April, the Congressional Budget Office raised its projection for 2018 gross domestic product growth by about 1.3 percentage points, to 3.3%, due in large part to the tax cuts and spending increases.

“These forecasts may be overly optimistic,” Messrs. Mahedy and Wilson said. “The [tax law] is in essence a large, mostly temporary tax cut hitting a hot economy.”

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