Originally published in The Wall Street Journal

November 15, 2016

Squaring Trumponomics With Reality

Corporate and personal tax cuts will boost growth. But debt will rise without reducing budget outlays.

By MARTIN FELDSTEIN

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President-elect Donald Trump will soon be working with Republican majorities in the House and Senate to reshape tax and spending laws to increase economic growth, raise living standards and protect America’s economic future. His challenge will be to do this in a way that is fiscally responsible as well as consistent with his campaign goals.

Jobs and corporate taxes. Although there are local pockets of high unemployment, the economy as a whole is essentially at full employment with a 4.9% unemployment rate in October. The key to better jobs is increased business investment in equipment and research to raise labor productivity, supplemented by more skill training in firms and community colleges. Tax reform could induce U.S. companies to bring back some of the $2 trillion of profits held abroad and could provide incentives for firms to spend those funds on investment and training.

Companies will bring back overseas funds if the U.S. shifts its method of taxing repatriated profits to the “territorial system” used by every other major industrial country, substituting a low tax on repatriated profits for the full U.S. corporate tax rate. A 10% tax on repatriated profits would provide a strong incentive to bring back funds instead of investing them abroad. Taxing profits that would otherwise have remained abroad would provide extra revenue with which to finance incentives for investment and training as well as a reduction in the current 35% tax rate on domestic profits.

Personal taxes. Top marginal tax rates have risen to 40% from 28% since the 1986 Reagan tax reforms. Substantial reductions in these rates can be achieved, as Mr. Trump promised in his campaign, without raising the deficit by eliminating deductions and credits for everything from buying an electric car to expensive local government services. Eliminating tax deductions for everything but charitable gifts and mortgage interest would raise enough revenue to finance a 10% tax cut across the board. Additional tax cuts could be financed by capping the exclusion for employer paid health insurance.

International trade rules. During the campaign Mr. Trump promised to tear up the North American Free Trade Agreement if he could not negotiate a substantial improvement. Revoking the agreement would put more than $600 billion of U.S. exports to Canada and Mexico in jeopardy. According to the U.S. Census Bureau, U.S. companies export more to Canada than they import from Canada. Including Mexico, total Nafta imports exceed exports by less than $40 billion, an amount equal to just one-quarter of 1% of GDP.

Although ending Nafta would be a mistake, trade experts agree that Nafta would benefit from being updated to reflect changes in the economy that have occurred in the past 22 years. Fortunately this can be done without scrapping the entire agreement by negotiating “side agreements” to protect U.S. interests.

National debt and Social Security. According to the Congressional Budget Office, the ratio of government debt to GDP has more than doubled in the past decade to 76% and is projected by the CBO to continue rising to more than 85% by 2026 on its way to over 100% in the following decade. Cutting spending on defense and on nondefense discretionary programs cannot reverse this debt explosion. Defense outlays are already scheduled to fall to 2.7% of GDP from 3.2% over the next decade, lower than any level since World War II. That decline needs to be reversed if the military is to protect the U.S. and its allies.

Reducing budget outlays requires slowing the growth of Medicare, Medicaid, ObamaCare and Social Security. Mr. Trump’s promised overhaul of ObamaCare will help to reduce government health spending, although it is an uphill battle because of the aging population and the technical changes that provide opportunities for expensive but effective health care.

Reforming Social Security, which now pays out more than it takes in, is therefore critical. Today’s benefits are paid only by drawing down the “trust-fund balance” accumulated in previous years, an accounting gimmick that adds to the overall budget deficit. Social Security actuaries predict on their most likely assumption that within the next 20 years the trust-fund balance will be exhausted, requiring a 25% cut in benefits at that time or a major jump in tax rates.

Mr. Trump has promised to protect Social Security beneficiaries. But if he wants to protect future retirees from a large benefit cut, he should work with Congress to enact a gradual rise in the age for full benefits, just as Ronald Reagan did in 1983. Since then life expectancy for Americans in their mid-60s has increased by three years. Gradually raising the age for full benefits to 70 years old from 67 for those now younger than 55 years old, while leaving open the option of getting actuarially equivalent benefits at an earlier age, would help to assure that future retirees don’t face a sharp cut in benefits.

Infrastructure. Although there appears to be bipartisan support for spending on roads, bridges and other infrastructure, this should be postponed until an economic downturn creates the need for fiscal stimulus. Meanwhile, it would be good to devote those dollars to reducing the national debt while drawing up specific investment plans to be ready during a downturn.

There are other perhaps less urgent problems that also need to be tackled. The good news is Mr. Trump can look forward to at least two years with the support of both houses of Congress to solve those problems and strengthen the U.S. economy.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor at Harvard and a member of the Journal’s board of contributors.