Economist Mark Zandi On Why Tax Cuts Are Not A 'Game-Changer,' Rising Deficits, And Why He Is Not A 'Fan' Of President Trump’s Economic Policies

The Trump Tax Cuts: No Game-Changer For IT Spending

Dr. Mark Zandi, chief economist for Moody’s Analytics, a leading provider of economic research, says the Trump tax cuts have been a "small tailwind" to IT spending but have been far from a "game-changer."

"I think it has helped buoy growth, and stronger growth helps support demand for all things including IT," said Zandi, who was co-founder of, which was acquired by Moody's Corp. "I don't think it has been a problem, but maybe a small tailwind to the IT industry broadly. But it is not a game-changer. At least not so far. We haven’t noticed any substantive pickup in IT-related investment."

Zandi said he believes that the Tax Cuts and Jobs Act, which went into effect Jan. 1, cutting the corporate tax rate from 35 percent to 21 percent with a 20 percent deduction for pass-through businesses, was a "mistake" because they are deficit-financed.

The tax cuts are being implemented on the back of a ballooning federal budget deficit, said Zandi. "The budget deficit this year is going to come in at $900 billion—up from $650 billion last year—and it is tracking over $1 trillion for next year," he said.

What is the state of the economy right now?

The economy is strong. Growth is robust. Unemployment is low and falling. Inflation is modest. Stock prices, housing values are near record highs. All the top-line economics statistics look very good—at least for the moment.

Are you surprised by the strength of the economy?

No. It is the result of fiscal stimulus. Deficit-financed tax cuts. Deficit-financed government spending increases. It is temporarily juicing up growth this year and into next. The economy is sticking to script.

Can you talk about the recent Federal Reserve interest rate increase and the impact you expect that to have on the economy?

The Fed rate increase was widely anticipated, and the Fed has laid out a plan for raising rates steadily through next year into 2020. Given that the economy is threatening to overheat with low unemployment that is declining and wage price pressure starting to develop, the Fed needs to normalize interest rates. So the Fed is now starting to work to slow growth. Since the recession it has all been about supporting growth— accommodative monetary policy, as they say. Now steadily but surely the monetary policy is going to become a restraint on growth as the Fed tries to slow the economy's growth rate so it doesn't overheat.

Do you agree with the rate hike?

I think the risk is that they are too slow—that they are not moving fast enough. If history is any guide, they need to be working a little more quickly here to normalize rates to take some of the steam out of the economy before it does overheat.

I do think asset markets are overvalued—stock prices are high relative to fair value; commercial real estate prices are high because cap rates are low; credit spreads in the bond market are thin. Even some housing markets are becoming a little overdone. So I think the Fed needs to be increasingly vigilant around asset markets that are overvalued. I think if anything they are a little slow here.

So you think the Fed needs to move quicker?

Right now, they are saying three rate hikes next year and one in 2020. My guess is when it is all said and done they'll have four rate hikes next year and one in 2020.

I am disagreeing on the margin. The risks for me are at a little bit different place than the average Fed number. I don't want to make too much of the disagreement. I think their policies are generally good ones.

Can you talk about the impact of the rate increase on the housing market and what you are seeing there?

Housing has obviously recovered significantly from the crash. In most places it has completely recovered, at least as measured by house prices. It is not quite there everywhere but almost everywhere.

So the market has found its way back. Most recently, however, it has kind of gone sideways. That reflects higher mortgage rates. Mortgage rates have risen since the tax cut. Also, the tax cuts themselves because of the elimination of various deductions that favor housing are starting to hurt housing demand and house price growth on places that heavily rely on those deductions like the Northeast, California and the Northwest. So there has been some cooling off. But in general, I think the housing market should hold its own. It should continue to be a modest source of growth.

Can you talk about the impact of the Tax Cuts and Jobs Act and the impact it has had on IT spending?

It hasn't had a large impact. I think it has helped buoy growth, and stronger growth helps support demand for all things including IT. I don't think it has been a problem, but maybe a small tailwind to the IT industry broadly. But it is not a game-changer. At least not so far. We haven’t noticed any substantive pickup in IT- related investment.

IT investment had been quite depressed throughout most of the economic expansion in part related to the recession itself. But also in part related to the fact that a lot of investment spending went into the energy sector to build out the fracking infrastructure. So IT sort of got less of the investable dollars during most of the expansion.

That is no longer the case. IT is getting its fair share. So that has been helpful. But the tax cut itself—the tax law itself—if it has had an impact it has really been a modest one on the margin.

What impact is digital transformation like Uber disrupting the taxi industry having on business investment in new game-changing, customer-facing solutions?

It is transformative. The IT sector is always obviously at the leading edge of change. It is always changing and evolving and kind of leads the way for the rest of the economy. It is key to driving innovation and the technological change necessary to support productivity gains and growth in our standard of living. It is by definition an industry of change. This time is no different. The technological backdrop is changing, shifting very rapidly. Most obviously and recently the advent of cloud computing and all the changes that is creating. People in this industry know better than anyone how challenging but also how much opportunity there is when things are changing as rapidly as they are. That will always be the case with the IT sector. It is on the vanguard of change.

Can you talk about the impact of the corporate tax cut from 35 percent to 21 percent and the pass-through deduction for businesses?

Obviously, it has been kind of a windfall particularly for C Corps. There, it has been a slam-dunk positive. The top marginal rate went from 35 percent to 21 percent. That cut went right to the bottom line. That was a very clear benefit to C Corps.

S Corps, it is less clear. It really depends on the industry—the profession, the way the S Corp. is set up. It is a lot more complicated. In fact, some of the rules around this are still being nailed down. So it is not quite clear exactly how much of a benefit it will be to S Corps.

My sense is net net it is a plus. But it is not the slam-dunk positive it is for C Corps. For them, it is an obvious benefit to their profitability.

Do you have any estimates of the Tax Cuts and Jobs Act’s impact on job creation?

In the near term, this year and next year, it is definitely a plus. It has probably added seven-tenths of 1 percentage point of growth to GDP. If you didn't have the tax cuts, the economy would grow this year 2.3 percent as opposed to 3 percent [GDP]. In terms of jobs, that probably ends up being 700,000 to 750,000 jobs this year.

Next year, you get a little bit less from the tax cuts because most of the benefits of the tax cuts are this year and a little bit next year. But by 2020, it actually becomes a negative because the benefit of the tax cuts goes away. You lower the rate and that is a big plus and then there is no further rate reductions and it becomes a little bit of a negative because you are left with somewhat higher interest rates. The GDP and employment effects pretty much go away and turn slightly negative by 2020 and 2021.

What is the long-term impact of the tax cuts?

In the long run, if you look out 10 years from now it probably has no net benefit to jobs or the economy. The key link between the tax cuts and the economy would be through investment and that happens to the cost of capital. The cost of capital declines because of the lower tax rate but you could also have higher rates because of the bigger deficits. So net net it is like a wash. Long run, it is hard to see much of any benefit in terms of jobs, GDP or any other economic statistic.

Is that also true also of the $840 billion American Recovery and Reinvestment Act stimulus under the Obama administration?

Yes. The stimulus after the collapse was designed to be all short term. It really wasn't about the long run. There were some elements like more infrastructure spending. But that was all about jump-starting the economy—ending the recession. That was designed to be temporary. This is also temporary. It is the same kind of stimulus, but it was kind of sold as this is going to support growth in the long run. And it would have if the tax cuts had been paid for by less government spending with the deficits not rising. But the deficits are ballooning. The budget deficit this year is going to come in at $900 billion—up from $650 billion last year and it is tracking over $1 trillion for next year.

So if you give tax cuts but you don't figure out how to pay for it—you borrow money for it—you are going nowhere because you are just raising interest rates and that offsets any benefit.

It is providing the same short-term boost to the economy that the 2009 stimulus did, but just like the 2009 stimulus it doesn't provide any long-term benefits to the economy.

What is the biggest danger to the economy as you look into the near future?

The most immediate threat is the trade war. If that continues to escalate, that is going to do damage. So far, the increase in tariffs is on about $300 billion imported goods. If that is the end of it, that's a negative but it is a small negative and it gets washed out by all the stimulus this year and next year.

If it continues to escalate, and at the moment it feels like it is going to, that is going to start doing some damage. That is going to hurt, and there are scenarios where it could knock the wind out of the economy. If the president, for example, imposes tariffs on all Chinese imported goods and all of the auto imports—things that he has been threatening—and our trading partners retaliate with commensurate response then that is a scenario where the U.S. economy essentially goes flat. So we don't get the growth and the stimulus is completely negated for this year and next year. So that is the most immediate threat.

Then there are other nagging threats like the Iranian oil sanctions that are coming up. You can see already oil prices are starting to jump. If the president imposes very stiff sanctions, then we could get $100 [per barrel] oil again—$4 per gallon of gasoline—that would hurt. Then there is Brexit early next year. And then, of course, the threat of overheating that will play out this year, next year going into 2020.

What kind of grade would you give the president in terms of policies with regard to the economy?

I am not a fan. I think the tax cuts were a mistake because they are deficit-financed. He has pushed through large increases in government spending that are all deficit-financed. His trade policy is completely wrong in my view. Completely wrong, in my view. It is wrong-headed. And I think his immigration policy is a huge mistake. We need more immigrants—not less. Businesses can't get workers of any kind, and that is just going to get worse.

I think the economy is all juiced up right now. That is very easy to do. It is not hard to go out and borrow money and juice up an economy, as we can see. The real talent is making sure you get higher sustainable long-term growth and that is not what we are going to get. If we stick with these policies, we are going to get a diminished economy in the long run.

Is the biggest threat long term the deficit?

That will ultimately be existential. Something has got to give. I don't know when the cliff occurs. I don't think it is this year, next year or the year after because we have a lot of resources. We are a wealthy nation with a reserve currency. We have a lot of fundamental positives that could drag us on for a long time.

But if you do the arithmetic, it is going to be a big problem for some generation down the road. So something has got to give. Something has got to change.

There is this old Winston Churchill saying that Americans try everything and then they ultimately do the right thing. I suspect that is what we are doing now.

Do you have any concerns about the midterm elections in terms of the impact on the economy?

The midterm elections could have a very significant impact on policy if the Republicans continue to maintain control over government—the presidency obviously, the Senate and the House. Then we are going to get another round of deficit-financed tax cuts, in all likelihood. They haven't shown any fiscal restraint, so I am not sure we would see any cuts in government spending. I am not sure what we would see there. You could see even bigger spending increases.

The president doesn't seem too worried about deficits. There could be some positive developments. The president has talked about infrastructure spending when he was running and soon after the election, which would probably be a good idea. Maybe that comes back to the fore. My point is there will be economic policy done if the Republicans maintain control.

If the Democrats win the House, then effectively government doesn't do much. It will be even hard for them to pass budgets and increase the debt ceiling and keep the government open. There are going to be budget battles. I think the president is going to fight for his wall. The Democrats won't want to give it to him, so we could see a government shutdown. So I think there is going to be gridlock and lots of battles and no real policy. Nothing really changes if the Democrats win the House. So there are two different outcomes depending on how the election goes.

Can you talk about your GDP estimates for 2018, 2019 and 2020?

This year 3 percent on the nose. In 2019, 2.7 percent on the nose and then in 2020 .08 percent growth. The recession risk will rise pretty significantly in 2020.

Can you talk about the 2020 outlook with a huge fall-off in GDP?

That is when all the stimulus goes away. There is no stimulus left by 2020. There is no [economic] tailwind from the stimulus and you are left with much higher interest rates. The Federal Reserve is going to be raising interest rates steadily between now and then. So monetary policy will be a constraint on growth. Fiscal and monetary policy up to this point have been tailwinds to the economy. By 2020 they both become headwinds to the economy. That is the key reason why growth slows as sharply as it does in 2020.

What is your advice to solution providers with regard to planning for 2020?

I think they should enjoy these good times, but they should be cautious. They shouldn't overextend [themselves]. They shouldn't leverage up and take on too much debt. They should try to make sure they have steady cash flow. They have to be careful not to get caught up in the hubris that people are starting to feel and overextend [themselves]. This is the time in the business cycle when people make mistakes and get caught when the recession actually occurs. You should be doing just the opposite of what your neighbor is doing. You should be more cautious—not less.

Has all the political divisiveness had an impact on the economy?

I think it has, but probably more so back earlier in the expansion. Hard to remember back, but in 2012, 2013 and 2014 there were a lot of bitter budget battles. We had the fiscal cliff. We had a couple of government shutdowns. There was brinkmanship over the debt ceiling. What is going on now is not nearly an issue as it was literally back then.

The divisiveness is not new. We have been dealing with this now really since the recession. It is definitely not a plus. But at this point, I am not sure it is that much of a negative. Certainly not as much of a negative as it was just a few years ago.

Are you optimistic or pessimistic as you look out many years?

I am optimistic. We have significant core fundamental strengths. We tend to forget that. We have the rule of law. I do business all over the world and I see it. The United States has rules and we follow them. And if people break the rules or disagree about the rules we have, we have an adjudication process that everyone trusts. That is a core fundamental strength.

I think we have the best assets. Our universities are a gem. They are the best in the world and we attract the best and the brightest from all over the world to come here—just as long as we remain open and don't close our doors and make it more difficult for people to come. We get the best. They come here. They start companies. They innovate and create wealth. That is a tremendous advantage. Even simple things like the English language. It is an easy language. Everyone speaks it all around the world. I do business everywhere on the planet and it is in English. The Chinese will have a very difficult time supplanting the United States just because of that simple fact. It is very difficult to speak Mandarin.

How strong are our political institutions?

I do feel those are being challenged right now. We do have strong political institutions. I think they ultimately will hold. People have historically trusted those political institutions: a free media, a court system, the Congress. We moan about the Congress but at the end of the day they do get things done. I don't think people realize how much they actually do.