The GOP's tax plan is unlikely to pay for itself.

An aging population puts pressure on entitlement spending, and so tax cuts that are not matched with spending cuts in other areas could be bad for America's fiscal position in the future.

The GOP is under pressure to have something to show the electorate before next year's midterms, even if it leads to a massive debt hangover later.



The definition of cognitive dissonance: when a country whose government spends almost 20% more than it brings in believes that it is suffering from a lack of fiscal stimulus.

The White House and GOP congressional leadership are trying to sell everyone on tax cuts that will pay for themselves and therefore will not at all risk blowing a hole through an already overextended government balance sheet. Aren't Republicans supposed to be the flag bearers of fiscal conservatism?

Even without the proposed tax relief, the deficit-to-gross-domestic-product ratio rises from 3.6% today to 5.2% a decade from now; the ratio of gross public debt to GDP surges a further 14 percentage points to 120%, as the costs associated with an ever-higher dependency ratio ensnare fiscal policy for years to come. What is missing in this budgetary debate is how cutting taxes can be accomplished as pension and healthcare costs balloon along with an aging population, without putting the nation's fiscal position in serious jeopardy.

Let's look at the historical record. The top marginal corporate income tax rate went from 46% in 1986 to 34% in 1992. We were all promised at the time that the tax cut would pay for itself. Did it? No. The deficit-to-GDP ratio rose to 5.1% from 4.7%, and the public-debt-to-GDP ratio soared to 63% from 47%. Well done!

The top personal tax rate went from 70% in 1980 to 50% in 1986 and then to 28% by 1990. So what did the deficit-to-GDP ratio do from 1980 to 1990? It rose to 4.1% from 2.3%; and the debt-to-GDP ratio soared to 55% from 32%. That is how well tax cuts pay for themselves. Today this ratio stands at over 100%; it has never been this high outside the World War II period.

House Speaker Paul Ryan. Alex Wong/Getty Images

The big difference between now and the most recent time we had US tax reform, in 1986, is that the median age of the baby boomer then was 31 years old, and today it is 62. The pressures on entitlement spending are intensifying sharply, and therefore a tax-reform package, which really is less about reform and more about relief, that is not coupled with restraint on the areas of spending that reside outside defense, veterans benefits, healthcare, pensions, and interest costs, will be ruinous for the generations in the future.

Or maybe the whole concept of "entitlements" has to be challenged — when you add up all the spending that is somehow mandated, it comes to 90% of the overall expenditure pie. I mean, isn't it a tad oxymoronic for a capitalist nation to even have such a spending promise to the population that is labeled "entitlements" — which literally means "the amount to which a person has a right." Well that "right" has to somehow be funded, either through current taxation or borrowed money, which means future taxation. It is tough to believe that Americans would have intentionally voted for more free lunches in last year's election, but that does seem to be the case.

So in reality, today's tax cut really represents tomorrow's tax hike if various elements of program spending are not brought under control. A tax cut that does not coincide with a taming of a more than 20% ratio of federal government spending to GDP is irresponsible — a spending ratio that is intractable and must be addressed or we will blow a massive hole in the nation's financial position that will dramatically impair future fiscal flexibility for our policymakers.

The House Ways and Means Committee member Rep. Tom Reed of New York in the Longworth House Office Building on Capitol Hill on November 6 with a stack of books documenting the federal tax code and related regulations. Chip Somodevilla / Staff

The problem is that the GOP has to show the electorate something before next year's midterms, even if the sugar high today leads to a further massive debt hangover down the road. And it is this dilemma of excessive indebtedness at every level of society (government, household, and business), which now totals an epic 250% of GDP (already exceeding the 228% peak that defined the end of the latest credit cycle and economic expansion), that is singularly responsible for the low levels of growth, underlying inflation, and bond yields for the better part of the past eight years.

Piling more debt onto a debt bubble in 2007 didn't make much sense, and doing so now with an even bigger debt excess doesn't either. Ask Japan how well this worked out for it over the decades. Also consider how well a Fed rate-hiking cycle played out with a 228% aggregate debt-to-GDP ratio at the peak of the most recent cycle — and how well it will play out now with that debt ratio above 250%.

There is something else to consider. While there are factions in Washington that claim that we are seeing supply-side economics in this GOP-devised fiscal plan, I would beg to differ. Tax reform would increase efficiencies, and yet this is just a small part of this plan.

A prudent fiscal policy for this stage of the cycle would involve cutting top marginal corporate income tax rates while broadening the base to ensure revenue neutrality. But this plan does not do that at all — it is a huge tax cut, not just at the business level but at the personal level, and yet there is no rationale right now for such relief at all. Top marginal rates on the individual side in the United States are near historical lows as is and are low among the developed world.

So there is going to very likely be a massive hole being drilled into the sanctity of the US public purse and less in the coffers to fund burgeoning requirements that come with an aging in the population. The first of the 78 million baby boomers are entering retirement, and the millennials behind them do not have the income to support the boomers as they morph from mere aging to the aged. The fiscal risks are substantial but seem to have no room in this current debate.

The Fed has been raising rates because, as it stands, it feels that aggregate demand is already straining scarce supply-side resources, especially in terms of labor availability. I cannot see how the demand-side impacts of the fiscal plan, so unwarranted at this late stage of the cycle, fail to cause the Fed to tighten policy more aggressively.

This is not 1986 under Reagan, which was mid-cycle with a 7% unemployment rate, or 2001 under Bush 43, which was early cycle with a near 6% unemployment rate, when the Fed can afford to accommodate the fiscal stimulus. This is year eight with a 4% jobless rate. So as Newton taught us, every action has an equal and opposite reaction, and this comes down to the Fed's reaction function. Pundits tend to forget how the dramatic relief from lower debt-service costs played such a crucial role in allowing the deficit to be so well contained in recent years, but that support is behind us now.

I estimate that if not for the current low-interest-rate structure, debt-service charges and the deficit would be $250 billion higher than they are today. But under current Congressional Budget Office projections, net interest charges go from $269 billion in 2017 to $818 billion in 2027, rivaling what the government will be spending on Medicare and severely impairing fiscal flexibility. At that time, more than 15 cents of every revenue dollar will be diverted toward servicing the debt, compared with 8 cents today. This is a dead-weight drag on the economy and the public purse that can be averted through macroeconomic policies that foster growth in the productive capacity or supply side of the economy, keeping inflation at bay even as demand growth expands, thereby freeing up vital financial resources needed to deal with the burgeoning demographic requirements and tough fiscal choices that lie ahead.

The fiscal plan being debated and pork-barreled in Congress, being mostly confined to a tax cut instead of true reform, misses what the country needs and will handcuff policymakers down the road. The future is about to be mortgaged, and nobody seems to mind.

David Rosenberg is chief economist and strategist at Gluskin Sheff, previous chief North America economist at Merrill Lynch, and the author of the daily economic report, "Breakfast with Dave."