United States of America: Staff Concluding Statement of the 2018 Article IV Mission
IMF News, June 14, 2018
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- Published: June 14, 2018
The Macroeconomic Outlook
- Near-term outlook: "strong growth and job creation."
- Unemployment: "already near levels not seen since the late 1960s."
- Contributors to acceleration: "near-term fiscal stimulus, a welcome recovery of private investment, and supportive financial conditions."
- Global context: "a favorable external environment with a broad-based pick up in global activity."
- Labor market status: "The balance of evidence suggests that the U.S. economy is beyond full employment."
- Inflation and wages:
- "core PCE inflation is expected to rise modestly above" 2 percent "by mid-year."
- "unit labor costs virtually unchanged over the past 2 years."
- "wages and unit labor costs are anticipated to increase at a modest pace" as slack diminishes.
- Labor force participation: "expected to be broadly stable over the near-term as cyclical forces offset the downward pull of demographics."
- Medium-term vulnerability: "a number of vulnerabilities are being built-up for the medium-term."
Fiscal Policy — Findings and Risks
- Policy changes enacted: "cut taxes and raised both defense and non-defense discretionary spending."
- Output effect: fiscal stimulus "is expected to raise output, cumulatively, by 1½ percent by 2020."
- Unemployment impact: "pushing the unemployment rate below 3½ percent."
- Supply-side effect: "raising the level of potential GDP (by a cumulative 0.3 percent by 2020)."
- Potential growth: "expected to return to its longer-term trend (of 1¾ percent) by 2021."
- Deregulation: potential modest positive level effects on real GDP (difficult to quantify).
- Deficit and debt trajectory:
- "the federal government deficit to exceed 4.5 percent of GDP by 2019."
- "This is nearly double what the deficit was just 3 years ago."
- "the federal debt will continue to climb, exceeding 90 percent of annual GDP by 2024" even with modest consolidation starting in 2020.
- Identified risks from procyclical fiscal policy:
- Higher public debt and unsustainable upward dynamic in debt-to-GDP.
- "A Greater Risk of an Inflation Surprise" that could force the Federal Reserve to tighten faster than markets price.
- "International Spillover Risks" including strains for borrowers in U.S. dollars, reversal of capital flows, upward pressure on the U.S. dollar.
- "The Risk of Future Recession" if output converges more abruptly to potential, possibly through a policy-induced recession.
- "Increased Global Imbalances": 2017 external position "moderately weaker than implied by medium-term fundamentals"; U.S. dollar "moderately overvalued"; current account deficit expected "to around 3½ percent of GDP by 2019-20."
- Infrastructure financing:
- Broad agreement on urgent need to increase federal infrastructure spending.
- Recently approved budget provides little incremental funding "despite the US$200 billion in appropriations requested by the administration."
- Recommendation: increase federal spending targeted "around competitive programs geared toward high priority projects" and design increases "within an overall spending envelope that allows for a steady reduction in the federal deficit and debt over the next several years."
Fiscal Policy — Recommendations (specific targets and measures)
- Fiscal target: "raise the primary fiscal surplus of the general government to around 1¼ percent of GDP (1½ percent of GDP for the federal government)" to put debt-to-GDP on a downward path.
- Suggested measures:
- Reform social security: "raising the income ceiling for contributions, indexing benefits to chained inflation, raising the retirement age, and instituting greater progressivity in the benefit structure."
- Contain healthcare cost inflation: "technological solutions that increase efficiency, greater cost sharing with beneficiaries, and changing mechanisms for remunerating healthcare providers."
- Increase federal revenue-GDP ratio via: "a broad-based carbon tax, a federal consumption tax, and a higher federal gas tax."
- Purpose: allow debt-to-GDP to fall and create space for support to low- and middle-income families and investments in human and physical capital.
Monetary Policy
- Policy stance in light of fiscal stimulus: "the Federal Reserve will need to raise policy rates at a faster pace to achieve its dual mandate."
- Tolerance for overshooting: "should be ready to accept some modest, temporary overshooting of its medium-term inflation goal."
- Policy rates: likely need "to rise for a time above the long-run neutral rate."
- FOMC vs staff: "FOMC participants’ median forecast suggests that both core inflation and the federal funds rate will rise at a moderately slower pace than in staff’s forecasts."
- Balance sheet normalization: "Barring a significant negative shock, the normalization of the balance sheet should proceed as outlined in the Fed’s policy normalization principles."
- Communication recommendations:
- "scheduling a press conference after every FOMC meeting"
- "publishing a quarterly monetary policy report (that details a central economic scenario, and description of risks around that baseline, that is endorsed by the FOMC)."
- Spillovers: near-term net effect of higher U.S. growth and interest rates "expected to be beneficial" for most economies; largest positive spillovers to Canada and Mexico. But stress is possible for leveraged firms/households and indebted sovereigns.
Tax Policy — Assessment and Recommendations
- Stated objectives of the Tax Cuts and Jobs Act (TCJA): simplify system, make business tax competitive, provide tax relief to lower- and middle-income Americans, lower statutory rates and broaden bases, increase equity, not provide income tax cuts for the wealthy, and achieve objectives "without adding to the fiscal deficit."
- Positive elements identified: reduce scope of personal income tax deductions, lower marginal tax rates, incentives for private investment, tackling base erosion and profit shifting, reduce debt bias.
- Concerns:
- High budgetary cost and "temporary nature of many provisions" creating tax policy uncertainty.
- Recommendation to "prevent the tax policy changes from adding to the fiscal deficit by increasing the revenue-to-GDP ratio (largely through a greater reliance on indirect taxes)."
- Business tax:
- Reduction in statutory business tax to "around the OECD average" and expensing of certain capital are positive.
- Issues: continued deductibility of interest with a cap incentivizes debt financing and introduces procyclical distortions.
- Temporary expensing "distorts the timing of firms’ investment decisions."
- Preferred reform: "move the U.S. to a cashflow tax, permanently allowing for the expensing of all capital outlays and fully eliminating the deduction for interest spending on newly-contracted debt."
- Concern: "very low, one-time tax rate on the stock of unrepatriated profits" conveys significant benefits when budget needs revenues.
- Personal income tax:
- Positive changes: eliminate most itemized deductions, raise standard deduction, eliminate personal exemptions, limit deduction for state and local taxes, reduce cap on mortgage interest deduction.
- Net effect: "provide greater benefits to those in the upper deciles of the income distribution."
- Recommendation: recalibrate rate structure to "concentrate tax relief to those earning close to or below the median income (with tax relief phasing out for those earning above 150 percent of the median income)."
- Additional: increase coverage and generosity of the Earned Income Tax Credit and eliminate loopholes/special regimes for high income earners (including the carried interest provision).
- Pass-throughs:
- Allowing a "20 percent deduction for pass-through income" may enable high-income individuals to reduce tax by recharacterizing income, counter to equity and simplification goals.
- TCJA contains guardrails, but their effectiveness is uncertain.
- International tax provisions (TCJA):
- The U.S. moved from global taxation with deferral to a modified territorial system embedding anti-avoidance measures and a minimum tax.
- Recommendations to strengthen design:
- Impose GILTI on a country-by-country basis rather than on average global profits.
- Eliminate the lower tax rate for exporters (FDII) to avoid distortions favoring exports over domestic sales.
- Apply BEAT only to transactions designed to transfer profits to related parties in low tax jurisdictions to reduce punitive impacts on legitimate commercial activities.
- Expected cross-border spillovers:
- Potential for reshaping international tax competition, possible shifts of profits/investment to lower tax jurisdictions, incentives for other jurisdictions to lower rates or adopt countervailing measures (faster depreciation, expensing, BEAT-like rules).
- Final impact on other countries "likely to vary considerably according to their circumstances."
Trade Policy
- U.S. trade regime: characterized as "very open" historically, supporting growth and job creation and encouraging global liberalization.
- Concerns about recent/proposed measures: "steps ... to impose new tariffs or otherwise restrict imports into the U.S."
- Identified risks of trade restrictions:
- "Catalyzing a cycle of retaliatory responses" that discourage investment.
- "Expanding the circumstances where countries choose to cite national security motivations" undermining the rules-based system.
- "Interrupting global and regional supply chains" damaging multinationals and dependent countries.
- Impacting vulnerable emerging and developing economies via financial market or commodity price volatility.
- Policy recommendations:
- "The U.S. and its trading partners should work constructively together to reduce trade barriers and to resolve trade and investment disagreements without resorting to tariff and non-tariff barriers."
- Bilateral trade balances "should not be viewed as either an anchor or a target."
- Focus on strengthening the rules-based, multilateral trading system and pursue ambitious bilateral and plurilateral agreements.
- Mitigate negative labor-market effects of trade through training, temporary income support, and job search assistance, including broader deployment of the existing trade adjustment assistance program.
Financial System Oversight — Findings and Recommendations
- Regulatory recalibration: some steps to tailor Dodd-Frank framework are underway.
- Key legislative and regulatory changes noted:
- Asset threshold for BHC systemic classification raised to US$250 billion (from US$50 billion previously implied), with Federal Reserve ability to deem BHCs with assets between US$100–250 billion as systemic.
- Suggestion: consider continuing regular stress-tests for banks with assets between US$100-250 billion; implement changes without weakening supervisors’ ability to take early remediation for BHCs below US$250 billion.
- Exclusions and exemptions: custodial assets excluded from Supplementary Leverage Ratio calculation; inclusion of highly liquid municipal bonds in High Quality Liquid Assets (subject to limits and haircuts); exemption of BHCs under US$10 billion from the Volcker rule.
- Proposed modification to eSLR for GSIBs: set ratio at 3 percent plus a buffer of 50 percent of the entity’s risk-based capital surcharge.
- Treasury proposals to change resolution framework by adding a special, streamlined bankruptcy procedure to complement Orderly Liquidation Authority and to circumscribe FDIC authority when resolving institutions.
- Treasury proposals to increase transparency and analytical rigor of FSOC designation process: comprehensive cost-benefit analysis, clear guidance, activity-based framework, designation as last resort.
- Assessment and concerns:
- Tailoring steps "likely to have only a modest impact on financial stability risks" in isolation; interactions among changes and procyclical fiscal policy may amplify risks.
- Medium-term financial vulnerabilities "have been steadily building and medium-term financial stability risks are elevated."
- Recommended safeguards:
- Preserve risk-based approach to regulation, supervision, and resolution.
- Maintain risk-based capital and liquidity standards as central tools.
- Maintain and strengthen Comprehensive Capital Analysis and Review, including assessment of liquidity and contagion risks.
- FSOC should continue addressing emerging threats; strengthen and more fully resource the Office of Financial Research.
- U.S. should remain engaged in developing the international financial regulatory architecture and committed to agreed international standards.
- Nonbank oversight gaps:
- Need stronger oversight for insurance companies and harmonized national standards/consolidated supervision.
- Concerns about proposals limiting federal engagement in international supervisory fora.
- Residual vulnerabilities: repo markets and money market funds, lack of comprehensive liquidity risk management framework for asset managers (including liquidity risk stress tests).
- Little progress on reforming housing finance system and government sponsored enterprises.
- Data-sharing impediments among regulatory agencies and "data blind spots, particularly related to the activities of nonbanks" hinder full risk assessment.
Competition Policy
- Observed trend: rising market power across industries with macroeconomic effects.
- "Markups have been rising steadily since the 1980s, and at an accelerated pace since 2010."
- Evidence: measures of industry concentration and profitability mirror increased market power; growth in rents accruing to a relatively small number of "superstar" firms.
- Macro implications: possible depression of future investment and R&D spending; downward pressure on the labor share of income.
- Policy responses:
- Where barriers to entry or anticompetitive behaviors exist, apply antitrust policies.
- Recognize cases where network effects or increasing returns justify oligopolistic structure, but ensure contestability.
- Taxation: supernormal profits/rents "should be taxed fairly" while avoiding taxing returns that arise from up-front investment (suggested instrument: cashflow tax).
- Consider regulation of entities providing key services when appropriate.
- Support displaced workers broadly with relocation or retraining, applying to all workers facing transitions from trade, technology, or market-structure shifts.
United States of America: Staff Concluding Statement of the 2018 Article IV Mission — June 14, 2018