When Tax Cuts Meet Mass Deportations

As we get more clarity on the nature of fiscal and mass deportation policies under a Trump Administration, it seems useful to consider what happens to the output gap.

Figure 1 depicts the evolution of GDP and potential GDP as projected in the August 2016 CBO Budget and Economic Outlook.

Figure 1: Reported GDP (blue), projected (red), and potential GDP (gray), in billions Ch2009$ SAAR. Source: BEA 2016Q3 second release, CBO Budget and Economic Outlook, August 2016.

Goldman Sachs (Phillips, “US Daily: Fiscal Boost: Mainly a 2018 Story,” Dec. 8, 2016; not online) predicts 0.4-0.5 ppts higher growth in 2017Q4-2018Q1, 0.25 ppts for the remainder of 2018.

In September 2016, the Center for American Progress estimated a long run (approximately 10 years) reduction of potential GDP of 2.3% relative to baseline, arising from the deportation of 11.3 million undocumented individuals (7 million workers). (Note: American Action Forum estimates 5.7% reduction in output 20 years out [1])

I summarize these two effects in Figure 2.

Figure 2: Reported GDP (blue), projection incorporating Goldman Sachs estimates (red), and potential GDP incorporating deportation (gray), in billions Ch2009$ SAAR. Source: BEA 2016Q3 second release, CBO Budget and Economic Outlook, August 2016, Goldman Sachs (Dec. 8, 2016), Center for American Progress/Edwards and Ortega.

Note that with this policy combination, output exceeds potential by 2018Q2. If CBO’s estimate of potential is too high, then potential is exceeded even earlier, and interest rates would tend to rise even faster than posited in this post. Dollar appreciation would be commensurately more pronounced.

Note I have assumed away fiscal cost of implementation of mass deportation (and hence expansionary Keynesian impacts on GDP); AAF estimates one-time costs at $100-300 billion, and 20 year costs at additional at $400-600 billion.