White House says tax reform needed to maintain 'momentum' after GDP growth

A chart from the Dept. of Commerce Bureau of Economic Analysis shows quarterly GDP growth since 2013. (BEA)

The U.S. economy grew at an annual rate of 3 percent in the third quarter of 2017, nearly as fast as in the previous quarter in spite of predictions that three major hurricanes would impede growth, but economists caution against taking this as proof the economy will continue soaring above the tepid growth numbers seen in recent years.

The data released by the Department of Commerce Friday marked the first time since 2014 that the country experienced two consecutive quarters of GDP growth of 3 percent or higher, following growth at 3.1 percent in the second quarter. The number could later be revised up or down.

Gross domestic product measures the total value of goods and services produced by the nation’s economy after accounting for the value of goods and services used in production. While quarterly growth has topped 3 percent several times since the financial collapse of 2008, the annual rate has remained below that level since 2005.

The second and third quarters of 2017 have come in at 3.1 and 3 percent respectively, but the slower 1.2 percent growth in the first quarter will likely keep this year’s annual GDP growth below 3 percent again.

Many economists had forecasted a drop in growth for the third quarter due to the impact of Hurricanes Harvey, Irma, and Maria. The storms have been blamed for the first month of net job losses in seven years in September, but they appear to have had little effect on the economy.

"Despite the damage from this year's hurricane season, the U.S. economy grew at 3 percent for the second quarter in a row,” said White House Press Secretary Sarah Sanders. “With unemployment at a 16-year low, the stock market at new highs and economic confidence soaring, the U.S. economy is surging under this president's leadership.”

Business investment in equipment surged at a rate of 8.6 growth, but consumer spending growth slipped slightly from the second quarter. Exports and nonresidential fixed investments were up in the third quarter, while imports and residential fixed investments were down.

Auto sales jumped to the highest level in over a decade in September, with much of that attributed to Americans replacing the hundreds of thousands of cars damaged by the storms. Other hurricane recovery expenditures may be more apparent in fourth quarter data.

“This looks like maybe the best quarter for autos in four years, after two slow quarters. We won’t know if things are turning back up or if this is just a blip of people replacing flooded cars until next year,” said Michael Madowitz, an economist at the Center for American Progress.

The Bureau of Economic Analysis said in a technical note accompanying Friday’s release that its calculations did account for lost private and government assets and insurance benefits related to Harvey and Irma, but it is not possible to specifically estimate the overall effect of the hurricanes on GDP.

The brunt of Hurricane Maria’s wrath was borne by Puerto Rico and the Virgin Islands, territories that are never included in BEA GDP analyses.

According to Desmond Lachman, a resident fellow at the American Enterprise Institute, economic conditions are favorable for increased household consumption with the stock market at record highs.

“Since Trump began, we’ve had a market rally that’s now something like 20%, so you’d expect that as households are feeling more comfortable in their wealth position they go out and spend,” he said.

Although many Americans are not sharing in the benefits of those stock gains, Lachman suggested the average worker should at least theoretically start seeing some effects of GDP growth.

“If the economy is doing better, it means there are going to be more jobs around, people’s wages are going to begin rising,” he said.

For the moment, that could put workers in a stronger bargaining position.

“The real question is, is it sustainable?” Lachman said, and he acknowledged the answer is not yet clear.

Josh Bivens of the Economic Policy Institute said in a statement that the topline growth number overstates the strength of the economy, with other indicators slowing and remaining in line with the Great Recession recovery period.

“All in all, today’s report is consistent with an economy that has steadily improved since mid-2009, with the pace of improvement too-slow but steady,” he said.

Justin Furman, former chairman of President Obama’s Council of Economic Advisers, observed that growth over the last four quarters averages out to 2.3 percent. In a tweet, he wrote, “we are still a ~2% growth economy. But a 2%+a little > 2%-a little.”

According to Madowitz, slower spending in the housing and service sectors reflected in the latest BEA report raises doubts that this quarter represents a fundamental change in the economy.

“I think you get a better signal from trends in parts of the economy over at least a few quarters—that’s even more important with the hurricanes this quarter,” he said.

President Trump has promised his policies will produce growth above 4 percent, but many economists are highly skeptical. Two quarters are not enough time to determine the significance of the uptick, but all economic data is being heavily scrutinized.

“Superficially we’re probably squinting harder looking for trends,” Madowitz said. “I doubt you’d hear much if we’d gone from 2.3 to 2.9 percent in the third year of an administration.”

Lachman expects the strong GDP figures to have at least two significant policy impacts in the months ahead.

“This is likely to strengthen the conviction at the Fed that they’re right to be on the path that they’re on raising interest rates,” he said. It increases the likelihood of an interest rate hike in December.

“This has got big implications for the tax cuts,” he added.

Republicans are attempting to pass the most substantial tax reform in 31 years. Final numbers for exactly what cuts and reforms they are seeking will not be released until next week, but some preliminary analyses have anticipated it will result in hundreds of billions of dollars in deficits. Some supporters maintain the tax cuts would pay for themselves through economic growth.

According to Lachman, the GOP will likely use the two quarters of growth to argue that Trump’s agenda is working and the cycle of anemic growth under President Obama has been broken, which is a presumptuous conclusion to reach based on six months of data.

“What’s dangerous about that is that’s what they’re going to base their tax reform on,” he said.

Republicans have indeed already seized on Friday’s report to argue that tax reform is necessary to keep the growth going.

“America can continue this momentum if Congress adopts our framework for major tax cuts and other key agenda items that will allow Americans to keep more of their money, make our businesses more competitive, and build an economy that works better for everyone,” Sanders said Friday in a White House statement.

House Ways and Means Committee Chairman Kevin Brady, R-Texas, who is working on finalizing the tax reform bill, also touted the growth and suggested tax cuts would make the economy even stronger.

“Next week, the Ways and Means Committee will introduce legislation to overhaul today’s miserably uncompetitive tax code and reinvigorate America’s economy – so our local businesses can grow and create more jobs, our workers can finally get a pay raise, and our families can keep more of what they earn,” he said in a statement.

According to Lachman, there is very little evidence to support the White House position that tax cuts will spur sustained 3 or 4 percent economic growth. There would probably be some positive effects on GDP, particularly from increased incentives for businesses to invest, but he pegs it around .1 or .2 percentage points, given the current state of the job market.

“The thing with the tax cuts this time around that’s very different from 1981 is the economy is close to full employment,” he said.

Though some economists disagree, Lachman does believe the labor market is nearing its peak. With productivity growth lagging, the population aging, and potential upheavals in trade policy looming, he does not expect tax cuts to produce significant continuous GDP growth.

“You could get a few quarters like that but not much more,” he said.

In theory, Madowitz said businesses might be holding back on investment until after future tax policy becomes clear, but he is unsure how much the outcome of the tax reform fight will alter business behavior.

“By the book, passing a tax cut can be good for growth if it boosts investment, while failing to pass one should have little effect…,” he said. “But we’ve actually seen a slight uptick in investment this year, so I’m not sure how much stock I put in the by-the-book answer right now.”

Trump has enacted relatively few economic policy changes so far, but the expectation of deregulation and tax cuts based on his campaign promises and tweets could be influencing corporate decisions and financial activity.

“If you’re looking from a longer run point of view, what people should be worried about is that a lot of the growth in economy has been achieved by pumping up the stock market, pumping up the bond market,” Lachman said.

If actual economic performance and investment do not match those expectations, the markets will not react well.

“At some stage, you’re going to get corrections there that would be a very big headwind,” he said.

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