The U.S. economy is on an improved growth trajectory, supported by tax reform, deregulation, and a pro-growth economic policy agenda that will raise U.S. productivity and strengthen labor force participation. Year-to-date economic indicators point to an economy that will expand by around 3.0 percent this year. Job growth has averaged approximately 200,000 per month over the first half of this year. Unemployment has continued to decline and, at 3.8 percent in May, is the lowest since 1969. Business investment has accelerated notably since late 2016, with year-over-year growth rising steadily over six consecutive quarters. Consumer sentiment remains buoyant and inflation has firmed, gradually climbing to levels at or near the Federal Reserve’s target. In this context, we agree with Fund’s staff view that “the near-term outlook for the U.S. economy is one of strong growth and job creation.”

However, we significantly disagree with the IMF’s real GDP growth projections in 2020 and beyond, its potential GDP estimates, and its long-term fiscal projections. We believe that staff understate the positive longer-term impact of tax reform and deregulation. The tax reform’s lower corporate tax rate, temporary new investment expensing provisions, and deductions for pass-through businesses will boost business investment and, along with other changes, catalyze more efficient capital allocation. Regulatory relief and other pro-growth initiatives will improve the business climate. Additionally, the Administration plans to reduce nondefense discretionary (NDD) spending over time that, together with a growing economy, will put the nation on a sounder fiscal path and reduce public debt as a share of GDP. Altogether, the Administration’s economic policies will spur greater investment in facilities and workers, boost productivity and wage growth, and draw more workers into the labor force. These deeper structural reforms will lift the U.S. economy to a higher sustained growth path.

That said, we welcome Fund staff’s independent and candid views on the U.S. economy.

Economic Projections: Our authorities expect real GDP growth to be 3.1 percent in 2018, remaining slightly above 3.0 percent through 2020. Although the IMF’s projections for 2018 and 2019 (2.9 and 2.7 percent) are slightly lower than ours, we broadly agree with Fund staff views on the near-term economic outlook.

Fund staff project much lower growth from 2020 onwards, in large part due to the temporary nature of some of the tax provisions. We believe that the Fund’s model underestimates the longer-term growth effect of the new tax law by focusing on its fiscal mechanics rather than the structural change. According to staff, the key features of the bill are “fiscal stimulus” in the early years followed by “fiscal tightening” in later years.

This approach misses the purpose of the tax reform, which is to promote structural changes that boost economic growth. The effect of tax cuts, temporary full expensing provisions, and regulatory relief comes from businesses responding to the policy changes. The tax cuts and temporary full expensing provision will incentivize large-scale capital investment, which will boost the quantity and quality of the overall capital stock. The Administration’s infrastructure investment plans will also substantially improve the capital stock over time. Finally, the Administration’s deregulation agenda – aimed at increasing dynamism in the community banking sector, the energy sector, and labor markets – will interact with higher quality human and physical capital to lead to a sustained increase in productivity growth.

Lowering the corporate tax rate also provides incentives for managers to focus more on creating profitable businesses, deepening the private capital stock, and investing in their work forces. The new law also provides smaller pass-through businesses with up to a 20 percent tax deduction, helping them compete with big companies and enhancing their ability to hire and train workers new to their industry. Altogether, these changes will raise productivity growth and strengthen labor force participation, counter the effect of demographic changes, and enhance human capital.

Fiscal Policy: Anchored by tax reform, our fiscal policy strategy supports growth and is oriented to address medium-term challenges. The Administration’s budget priorities also aim to better control federal spending, particularly NDD expenditures, while allocating greater federal outlays for defense and supporting greater infrastructure spending. The December 2017 comprehensive personal and corporate tax reform was the most significant reform since 1986. Core elements of the tax plan include the following:

• A reduction in the U.S. corporate tax rate from 35 percent to 21 percent. For many years, the United States had the highest corporate tax rate among major economies, which discouraged investment in the United States. The 21 percent rate is slightly below the OECD average and is not a “race to the bottom.” Instead, since the new rate is accompanied by tax reform and changes in international tax provisions, it could stimulate a race to better policies globally.

• The alignment of the U.S. international tax system with the territorial systems of most U.S. trading partners and implementation of many recommendations from the G-20/ OECD BEPS project, consistent with the theme of combating stateless income.

• Imposition of a U.S. tax on low-taxed excess earnings of controlled foreign corporations of U.S. parented groups on which U.S. tax was previously deferred, as well as limitation of base erosion via interest and other deductible payments, both of which are consistent with BEPS goals.

• Simplification of the personal tax system and temporarily lowering marginal tax rates across all income levels, with the largest benefits for the middle class. The bill also reforms the burdensome Alternative Minimum Tax, almost doubles the standard deduction, and bolsters the child credit system to support working families.

The FY 2019 Budget projects a deficit of 4.7 percent of GDP in FY 2019, a moderate increase from the estimated 4.2 percent of GDP for FY 2018. Over the ten-year budget window, the Administration’s proposals aim to reduce NDD spending by over 40 percent in real terms, and restrain spending in mandatory programs, including by reforming health care. We recognize these objectives will require considerable effort.

Additionally, the Administration’s infrastructure plan adds $200 billion in federal spending over FY 2019–2028, aimed at generating $1.5 trillion in overall public and private investment. Of the $200 billion in the infrastructure initiative, $100 billion will create an Incentives Program that matches states/localities up to 20 percent for new dedicated revenue streams for qualified infrastructure investments. These measures will improve the U.S. overall capital stock and thereby boost potential growth. Higher growth will fuel higher government revenues, which, coupled with a decline in NDD spending, will put the headline deficit on a downward path as a percent of GDP.

Monetary Policy: The Federal Reserve continues to make progress toward its goal of maximum employment and price stability. The labor market has continued to strengthen, with the unemployment rate falling to 3.8 percent in May from 4.3 percent a year earlier. Job gains have been strong in recent months, while wage growth has moderately increased. Broad measures of labor market slack have also fallen, though the degree of slack remains somewhat inconclusive.

Inflation has moved up from a year ago, with personal-consumption expenditure inflation close to the Federal Open Market Committee’s (FOMC) target of 2.0 percent. The FOMC judges that the economy will continue to expand at a moderate pace over the medium-term and that labor market conditions will remain strong. Inflation is expected to run near the FOMC’s 2.0 percent objective over the medium-term, and risks to the economic outlook appear balanced.

The FOMC expects that improving economic conditions will warrant further gradual federal funds rate increases to sustain a healthy labor market and stabilize inflation around its target. According to the FOMC, the stance of policy remains accommodative. At the same time, the FOMC has repeatedly stated that the monetary policy path is not on a preset course and will remain data dependent. The FOMC remains committed to clear policy communication.

Furthermore, the FOMC began implementing a balance sheet normalization program last fall. The approach has been well-communicated and has been implemented in a regular and predictable manner. The balance sheet is not intended to be an active tool for monetary policy in normal times, while the FOMC is prepared to adjust the details of its approach to policy normalization considering economic and financial developments.

Financial Regulation: The President recently signed the Economic Growth, Regulatory Relief, and Consumer Protection Act. This legislation modernizes and recalibrates financial regulation to help banks, particularly community and regional banks, more efficiently and effectively allocate capital to businesses and consumers. This bill strikes the appropriate balance between addressing risks to the financial system and facilitating economic growth.

More broadly, we believe that the U.S. financial system is on strong footing, with moderate financial stability risks. Most large U.S. banks remain well-capitalized and highly liquid, and reliance on short-term wholesale funding has continued to decline. Higher valuation pressure across a range of asset markets has not been accompanied by increased leverage in the financial sector. Recent financial market volatility has not materially impacted financial sector soundness, and large financial institutions are well positioned to absorb further financial market stress should it materialize.

Trade/External Sector: The United States has one of the most open trade policy regimes and economies in the world. We seek to promote fair and reciprocal trade, and to press for a level playing field for U.S. firms. Importantly, the Administration believes that all countries should remove barriers to trade.

However, the Administration has clearly articulated that the United States will no longer accept being in a position in which the unfair practices of our trading partners harm U.S. firms and workers. To that end, policies are intended to address circumstances where injurious market distortions have occurred; where critical U.S. national security concerns are relevant; or where the playing field for U.S. firms and workers is otherwise not level.

The Administration’s trade policy agenda seeks to address serious, long-term challenges that have been facing the multilateral trading system. We strongly disagree with Fund staff’s assessment that our recent trade measures would move the globe further from an open, fair, and rules-based trade system. Instead, the Administration’s trade policies seek to move the global economy closer to a free, fair, and reciprocal trading system.

Competition Policy: We note Fund staff’s focus on competition issues and policy in the United States, which we believe deserve academic attention by the relevant experts At the same time, we disagree with staff’s approach to the topic and their conclusions. Evidence pointing to a broad trend in increased market power is inconclusive. We note that this is a developing literature, and not all researchers have found the markups to be trending upward. Further, analysis on higher estimated markups does not necessarily provide a reliable measure of market power. A higher estimated markup also could be the result of costs being driven down, with some portion of the marginal cost savings passed through to consumers.

Moreover, the relationship between higher markups and competition policy is unclear, making it difficult to define any policy implications, including staff’s recommended tax scheme. We do not see a strong economic argument for imposing a tax that could discourage firms from lowering their costs to their own benefit and that of their customers.