Did the 'Tax Cuts and Jobs Act of 2017' Hurt Republicans In 2018?
While it’s accepted wisdom that the political party in control of the White House tends to lose House and Senate seats in midterm elections, it’s also supposedly a truism that “It’s the economy, stupid!” Applying the first known quantity to the elections from earlier this month, the Democrats won 40 Republican House seats for a net gain of 38, while Republicans have added 3 Senate seats to their 51 Senate seat majority.
Where all of this gets complicated is that the U.S. economy is doing very well. Crucial here is that the latter is acknowledged by both sides. Evidence supporting the previous claim can be found in the endlessly obtuse pieces of economic commentary in the New York Times about how soaring economic growth is harmful because it allegedly pushes the economy beyond its “speed limit” on the way to “inflation.”
About what is ridiculous, most economists believe in the impossibility that is too much economic growth whereby the prosperity leads to an inflationary breakout that stops the boom. Back to reality, economic growth is driven by investment, and investment is always and everywhere the driver of falling prices thanks to investment fostering the production of exponentially more goods and services in concert with the usage of exponentially fewer workers and factories. Without going into too much detail, there’s no correlation between rising economic growth and inflation. None. But that’s a digression. This piece aims to discuss the electoral implications of a booming economy.
Specifically, why did the Democrats have their best House year since 1974? Useful about 1974 is that back then there was a slow-economic-growth problem born of economy sapping inflation. The source of the inflation was President Nixon’s decision to delink the dollar from gold in 1971 (with brevity in mind), only to officially sever the link two years later. The falling dollar naturally resulted in that same dollar commanding fewer and fewer goods in the marketplace (this is true inflation), not to mention that currency devaluation feeds on itself through reduced investment without which prices remain stubbornly high. Stating what should be obvious, the investors without whom there is no economic growth are going to be less likely to put their money to work if any returns are set to come back in devalued dollars. Looked at through an economic prism, and on the assumption that elections are always about the economy, it’s no surprise (with or without Watergate) that the GOP lost seats in 1974. The economy was awful thanks to true inflation that always correlates with slow growth.
Ok, but once again, what happened this time? Why, with the economy on the upswing, would the Democrats take so many seats from the Republicans? Some will simply point to the polarizing nature of President Trump as the answer. Such a view doesn’t seem totally unreasonable, plus love or hate Trump, Washington needs ballast. Too much power vested in one political party can be corrupting, and bad for the economy. It’s possible the electorate in total was acting wisely just as markets are wise: what limits Washington (gridlock) is good for the electorate. The electorate secured gridlock.
Still, if voters in total always coalesce around the gridlock that is meant to limit federal activity, then it’s also true that elections aren’t always about the economy. As opposed to them rewarding the Party that delivers the policies that correlate with economic growth, the electorate is instead simply voting for the gridlock that delivers an absence of policy that logically correlates with prosperity. There’s a difference between the two.
Or maybe there’s no hard and fast rule when it comes to elections. Maybe the actions of the electorate can’t be reduced to slogans that always tell the tale. Maybe this election was about tax cuts that Republicans overstated the impact of. Specifically, maybe Republicans didn’t cut taxes enough while at the same time raising them on the voters most capable of actually enhancing economic output.
Indeed, lost in all the bouquets thrown Trump’s way as a Reaganesque tax cutter is that a capped state-and-local tax deduction (SALT) at $10,000 is resulting in tax increases for individuals who reside in high tax states. While it’s fun to imagine that that only Democrats live in New York and California, many high-earning Republicans do too. And in Orange County, a longtime Republican stronghold in the Golden State, Democrats won all the seats. Yes, you read that right: Orange County will not send a single Republican to Congress for the first time since 1940. Who knows, but in a divided country is it possible that one factor tipping certain close elections was a Republican tax bill that improperly penalized the rich?
Looked at more broadly, it’s hard not to at least wonder. As the New York Times reported last week, repeal of SALT from a taxing perspective “skews heavily toward households earning $200,000 or more.” Well, of course it does. For the average earner, the standard deduction or even the capped $10,000 deduction is more than enough to overcome the tax increase that was built into the GOP bill. Not so for the rich.
All of this matters from an economic growth perspective given a basic truth repeated over and over again in this column: the rich are generally the only people with the means to drive economic growth simply because they have abundant wealth that goes unspent. The previous point can’t be minimized when we remember that contrary to Keynesian orthodoxy, consumption is not what drives economic growth. Investment does. More than Republican strategists will ever admit, the Republicans by their own admission crafted a very Keynesian tax bill last year. Remember all the talk from them that the bill wouldn’t favor the rich? They weren’t lying. That they weren’t is a reminder that the economy booms despite a tax bill that wasn’t very stimulative, by design. Any tax legislation aimed at raising rates on those with the most is as a rule going to limit what would be much greater growth for it limiting how much those with the most are able to invest.
Some will say that getting rid of SALT was a good idea, but that's debatable. Isn't the point of federalism that most spending and taxation should occur locally so that people can choose their policy bliss while the federal government does very little? It won't happen, but a truly Republican tax bill meant to encourage local policymaking would be one that calls for crediting taxes paid to state and local governments against total federal taxes paid as a way of limiting federal revenue collections, all the while encouraging the localization of policy.
Where it gets interesting is to yet again contemplate how much the tax-increase aspects of the 2017 bill influenced voters. What happened in Orange County perhaps offers a clue that Republican voters were none-too-happy with tax legislation that needlessly raised rates on those most capable of driving growth. Sad here is that despite hiking taxes on the rich, the media pretended that the GOP slashed rates on high earners. It’s possible the electorate revealed how wrongheaded was the media’s analysis of the tax cut, and also how dense Republican tax strategists can be.