(Bloomberg Opinion) -- On Tuesday President Donald Trump was unable to say whether he supported the single most viable idea for forestalling a recession: a payroll tax cut. It’s not a hard question — and by promising to make the cut temporary, he could increase the chances of it actually happening.
The worsening U.S. economic outlook has sparked a blame game in Washington. Trump blames the Federal Reserve for raising rates. The Fed blames the president for initiating a trade war. The Republicans blame the Democrats for proposing new taxes, and the Democrats blame the Republicans for passing a tax bill that did too little to stimulate the economy.
To review: The president is essentially right that the Fed was too aggressive in raising rates in 2018 and that it should now reverse course. The Fed has failed to hit its inflation target ever since the Great Recession. The closest it came was in mid-2018, when the economy was riding high from the direct yet temporary stimulus provided by tax reform.
Higher interest rates are always a headwind for growth and employment. They are necessary, however, when the economy is at risk of overheating. But inflation has been below the Fed’s target, so there is no reason that it should be slowing growth in the first place. This is made all the worse by the fact that the global economy is starting to slip, putting downward pressure on U.S. exports.
Speaking of which, the Fed has had to deal with the damage of Trump’s escalating trade war. And the strong downdraft from that war and the thus-far disappointing results of the tax cut are linked. Trump’s tariffs are bad, but not enough to bring down the large and diverse U.S. economy. What has made the trade war so damaging is the level of uncertainty it’s generating.
That uncertainty is leading businesses to hold off on investment, thus undercutting one of the primary purposes of the 2017 tax law. Meanwhile, Democrats are busily promising to repeal tax reform if they win the presidency, creating a double-edged sword: If Trump is re-elected, the trade insanity continues. If he is defeated, the current investment incentives do not.
All of which raises the question: What can be done for the U.S. economy and the millions of workers who are just now seeing their wages rise and their employment prospects improve?
In an ideal world, Trump would sign an immediate ceasefire in the trade war; the Fed would commit to cutting rates until the average level of inflation since the Great Recession was approaching 2%; and Democrats would agree to take any tax increases off the table so long as interest rates on government debt were below 4%.
None of that has any chance of happening. A viable Plan B, however, would be something that the president, strangely enough, seems to be pushing — against objections of his economic advisers. Congress should pass a 2% payroll tax cut for both employees and employers, and set it to expire at the end of 2022.
A two-and-half year tax holiday would give the economy plenty of time to recover from its current rough patch. It would also take the issue off the table until after the 2022 midterms. That would allow whoever wins the White House next year time to establish a core agenda without worrying about the backlash from an automatic tax increase.
It has something for everyone to like. For Trump and Republicans, it’s a tax cut. For Democrats, it’s a benefit that accrues mostly to middle- and lower-income taxpayers. For the Fed, it’s breathing room, giving it time to figure out how to attack the problem of persistently low inflation. And for the American people, it might be their last, best hope at ensuring the recovery doesn’t come to a stop just as the most marginalized workers are beginning to benefit.
To contact the editor responsible for this story: Michael Newman at mnewman43@bloomberg.net
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Karl W. Smith is a former assistant professor of economics at the University of North Carolina's school of government and founder of the blog Modeled Behavior.
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