While tax cuts grab the headlines, the bigger issue for long-term economic growth is government spending. Tax receipts are above their long-term average as a share of GDP, but the government is still spending over $650 billion more than it takes in. And this government spending crowds out private sector growth.
Government spending since 2000 has risen from 17.6% of GDP (when the US had a surplus) to around 21% of GDP today. The more the government spends, the more it crowds out private sector growth and the slower the economy grows. It's not that complicated.
Yes, tax cuts can help boost growth – at least temporarily – but without cutting spending, faster economic growth can't be sustained, and eventually politicians will push tax rates back up in an attempt to pay the tab. Tax cuts are never "permanent" unless spending is contained.
We got into the current budget mess thanks to the 2009 jump in government spending as TARP and other supposed temporary stimulus programs added $535 billion to already excessive federal spending. This pushed spending as a share of GDP to 24.4% from 20.2% in a single year. But instead of unwinding that spending as the economy recovered from the financial crisis, government embraced Milton Friedman's maxim that "nothing is as permanent as a temporary government program."
As Friedman predicted, government spending never went back to its 2008, pre-crisis level of about $3 trillion per year. It flat-lined near $3.5 trillion over the next five years as the sequester helped contain it, but the sequester has since been scuttled and spending is now up to $3.98 trillion with the new 2018 budget, passed by the House and Senate, pushing it to $4.1 trillion.
Over recent decades, the US has never balanced its budget when spending was greater than 19.5% of GDP. As a result, unless tax cuts boost the economic growth rate high enough above the growth rate of spending, tax cuts will not have a long-term impact on GDP and living standards.
That said, two pieces of good news have developed in recent weeks. First, tax cuts seem to be on the way. Second, if the $4.1 trillion budget is passed, spending will be up around 3% from 2017, slightly slower than nominal GDP. This slower growth in spending paired with better policies should help the economy to accelerate in 2018 and drop spending to around 20.5% of GDP.
But what if Congress and the President went one step further and froze spending at the current bloated level? As the chart in the included PDF shows, if we make the conservative assumption that tax revenues remain near their historical 65-year average of 17.5% of GDP and if nominal GDP (real GDP plus inflation) grows only 3.5% annually – in-line with the 3.6% annual growth rate over the past five years – with a spending freeze, the budget would balance in six years (2023). If fewer regulations and tax cuts boost nominal growth the budget would be balanced even sooner.