Prognosticating about the economic impact of Donald Trump’s presidency is a task fraught with uncertainty and challenge. Is he truly committed to achieving his promised effects? Can he “Make America Great Again” by bringing manufacturing jobs back to America, protecting Social Security, and replacing Obamacare with “something terrific”? Is he going to assemble the best people, evaluate the challenges with fresh eyes, and figure out how best to deliver on those promises? Or will he be content with boilerplate policy proposals of the GOP establishment to reduce government regulation, cut corporate and business taxes, slash income tax rates, and repeal the inheritance tax?
At the heart of his campaign, Trump promised he would dedicate himself to working for the middle class. In January 2016 he stated it expressly, “If I become president, I couldn’t care less about my company…. I want to make America rich again and to make America great again.” In the second debate with Hillary Clinton he openly acknowledged the inequity of the tax preferences from which he personally benefited. He accurately defended his use of those preferences as sound business judgment exercised in accordance with the law and blamed Hillary Clinton personally and the political leadership as a class for having created those preferential laws. He attacked Clinton’s close ties to Wall Street and railed against a system rigged against the middle class. Repeatedly throughout the campaign he asserted that, “Nobody knows the system better than me… which is why I alone can fix it.”
He may, in fact, have been right. His election has offered him a unique opportunity to change the system in Washington. Trump routed the establishment leadership of both political parties. While Clinton personified the status quo, Trump offered to upset the apple cart and implement radical change. And with Republicans in control of both houses of Congress and mindful of Trump’s success in radicalizing their base, he has the potential to push through more radical change than any of his predecessors for at least the last three decades.
Unfortunately, many of his proposed policy changes are in direct conflict with his promised effects. Trump’s economic vision seems to involve an autocratic combination of cronyism and central planning. The ad hoc application of coercion and cronyism and targeted penalties and preferential tax bribes aimed at specific companies does not represent sound, sustainable policy. Yet every economic proposal he makes seems tied to either incentive tax treatment of investors who do his bidding or punishment for those who fail to maintain his favor.
Over and over he has promised that he, personally, is going to “Make America Great Again,” and that he’s going to do it by negotiating better deals. His vision of how to stimulate a vibrant economy does not appear to entail establishing a level playing field and carefully calibrated incentives—but simply the belief that by combining the strength of his personality with the power of the presidency he can force successful outcomes.
It’s not hard to imagine how Trump came to his view of how the economy works. He made his fame and fortune as a big city, big project real estate developer, an arena where knowing people in high places and extracting political support and tax concessions is often critical to success. He has bragged openly about buying access and political influence throughout his career. Now he’s filled his cabinet with like-minded billionaires and, despite his populist rhetoric, instead of reducing preferential tax treatment of the already privileged, he appears intent on increasing it. Cronyism is clearly on the ascent.
Trump’s obsession with dealmaking and winning suggests a highly transactional view of the world—and a predisposition toward relationships and influence rather than facts or principle. Trump never promised a level playing field. He promised to dominate his political opposition and the world stage so thoroughly that “America will get tired of winning.”
While liberals and progressives are in open revolt as they focus on the social implications of Trump’s autocratic (and arguably xenophobic) vision for America, so far the equity markets appear confident that a government populated with billionaires is going to smile brightly upon investors. Between Election Day and Trump’s inauguration, the average gain among the major U.S. indexes was 7.1 percent, and despite early failures with the administration’s legislative agenda, by April 1 had added another 5 percent, for an annualized return exceeding 30 percent.
But while volatility is a trader’s friend, it tends to be an enemy to those who believe investment valuations should reflect expectations of future earnings. The recent market run-up has far more to do with speculative overenthusiasm than with any reasonable expectation of sustained improvement in the underlying business environment. It is likely that the optimism now sustaining that trend will come abruptly crashing down when the euphoria begins to wane.
Trump’s Economic Vision
Key elements of the Trump economic vision—his support of protectionism, his promises not to reduce Social Security or Medicare benefits, and an apparent disregard for rising debt levels—are in direct conflict with long-term policy priorities for the Republican Congress. As evidenced by the early failure of Obamacare repeal-and-replace efforts, the conflicts between promises and plans are becoming increasingly difficult to ignore as Trump and Congress attempt to negotiate a detailed legislative agenda. So how might the Trump presidency continue to play out, and what are the implications for the economy and the restructuring advisory environment?
While specific details have yet to be negotiated with the Republican leadership in Congress, there are four key elements of Trump’s proposed/assumed tax and economic plans: 1) relaxation of administrative and regulatory requirements, 2) tax reductions, 3) protectionist trade policy initiatives, and 4) infrastructure investment programs.
Trump and the Republican Party share a dismissive antipathy toward administrative and regulatory controls and are moving rapidly to reduce government oversight. Across multiple departments—education, energy, environmental protection, health, labor, and others—Trump has appointed cabinet leaders who have been actively skeptical of the organizations they now lead and are aggressively reprioritizing departmental mandates. Cost/benefit analysis of regulation is rapidly being replaced with cost-reduction initiatives aimed directly at rolling back government oversight.
The Trump administration’s view of business is not just laissez-faire; it seeks to actively promote and support growth by removing environmental hurdles and regulatory requirements across multiple arenas. Executive orders rolling back provisions of Dodd-Frank and the Consumer Protection Agency, and fast-tracking construction of the Keystone/Dakota Pipelines are early high-profile examples of the activist intentions of the new administration. It is no coincidence that finance and energy stocks have been leading the surge in equity valuations.
However, advancing elements two through four of Trump’s plan will prove much more difficult. Analyses published by the Tax Policy Center and the Congressional Budget Office estimate Trump’s tax reduction proposals would add between $6 trillion and $9 trillion to the deficit over the 10-year forecast horizon—with 77 percent of the tax benefits flowing to taxpayers in the top 10 percent of income distribution. If there are any fiscal conservatives left in Congress, that will be a very difficult plan to approve, unless it is accompanied by deep cuts to entitlement spending programs, which Trump has simultaneously promised to protect.
Moreover, even if those tax cuts are implemented, because they are skewed so highly toward the upper income population and investment class, they will do little to stimulate consumer demand, which represents nearly 70 percent of the U.S. economy. There is a much higher probability they would stimulate a run-up in asset valuations than fundamental improvement in the underlying economy. Combined with the relaxation of financial regulatory controls, it is a recipe for reinflating the financial bubble that set the stage for the 2008 recession.
Likewise, although Trump’s trade policy threats motivated much of his voting support, they are at odds with both economic theory and the Republican predilection. Most important, whether the tool of choice is House Speaker Paul Ryan’s proposed border adjustment tax or Trump’s punitive tariff proposals, the effect on U.S. consumers would be a regressive pass-through increase in prices with a corresponding decrease in aggregate demand.
Perhaps the least well-defined element of Trump’s economic proposals is his call to rebuild and upgrade America’s deteriorating infrastructure. Done right, it could offer a highly productive path to increased economic activity and future prosperity. The federal interstate highway system is widely credited with being a key contributor to the rapid growth and shared prosperity of the post-war boom.
There is a strong consensus that the entire scope of the country’s public infrastructure—its roads, bridges, tunnels, airports, railways, dams, and electrical grid—has been neglected and is in accelerating stages of disrepair. The maintenance and modernization of these critical public facilities could employ thousands of people while improving economic efficiency and the quality of life across the breadth of the U.S. Yet here again, Trump’s proposal runs counter to his party’s established policy stance: dogmatic insistence that all government is bad government. Republicans have consistently and aggressively opposed funding programs that either expand the scope of government or increase the deficit. On its face, Trump’s call for increased infrastructure spending appears to do both.
The administration’s response to budgetary objections is privatization, by offering investors special tax incentives and loan/debt service guarantees. It’s very consistent with Trump’s personal experience in leveraging government tax preferences and other support to build his private real estate empire. For many conservatives with a laissez-faire, small-government, pro-business bias that suggests that private enterprise can get things done faster and cheaper, this may seem attractive.
But the prime driver of those efficiencies is the trade-off between risk and reward. As risks and rewards become skewed by subsidies and guarantees, those efficiencies begin to dissipate, overpowered in the race to feed at the public trough. Moreover, the incremental operating costs and debt obligations created by privatizing these programs will not just disappear, they will become a notably visible drag on the economy.
At present, Republican congressional leadership seems prepared to acquiesce to nearly anything Trump tweets, in anticipation that they will have control of the legislative tax reform package. But it is not at all clear that Trump will, or should, cede that control. If Trump allows Republicans to gut working class health and welfare programs while showering new tax preferences on investors and transferring America’s infrastructure into the hands of Wall Street investment bankers, he will be openly abandoning his promises to the middle class.
The central obstacle to key beneficial elements of Trump’s agenda, or indeed to any truly meaningful tax reform program, is opposition to revenue increases necessary to stabilize the budget and reduce the growing debt burden.
In summary, the author’s forecast for the economy in general and the turnaround industry specifically is this: Buckle up. It’s going to be a bumpy ride for the following reasons:
There is almost no chance Congress will do the right thing as opposed to taking the politically expedient path—address meaningful revenue reform and properly fund an effective stimulus investment plan—unless Trump shifts course, aggressively leads the charge, and demands that they do so.
A More Promising Approach to Tax Reform
On his journey to the presidency, Trump hijacked the Republican Party, but his affiliation with its trickle-down economic dogma appears to be a recent phenomenon, not a long-term core belief. In 1999 Trump proposed a one-time 14.25 percent tax against multimillionaire net fortunes to be used to retire the national debt, reduce taxes on the middle class, and shore up Social Security. Offering details in his book The America We Deserve, he wrote, “It is only reasonable to shift the burden to those most able to pay” and, “Taxes represent the cost of freedom and its defense. It is a small price.” A less draconian variation of the wealth tax he proposed then, imposed on a sustained annual basis, could offer many of those same benefits—and more.
Trump’s primary appeal during his campaign was his outsider status. He gained his electoral majority by attacking the political cronyism of both parties. He has already acknowledged the inequities embedded in the tax code and is perhaps uniquely positioned among modern presidents to abandon the flawed dogma of both parties that obstructs meaningful and efficient tax reform. If he rejects the GOP’s efforts to expand and protect investment tax preferences and revisits the ideas he offered in 1999, he could reshape tax policy to benefit the middle class while simultaneously stimulating economic growth.
Structural tax preferences aimed at inflating and protecting existing wealth distort investment incentives and undermine a productive economy. Government shouldn’t need to bribe investors with preferential treatment to get them to act in their own interest. But the U.S. should stop sheltering unproductive and low-profit capital from taxation.
Efficient comprehensive tax reform could be achieved with two simple components:
The bulk of the tax cut on wages and salaries would accrue directly to the working class and stimulate consumer demand, which is the primary driver of economic activity and growth. The removal of structural preferences toward wealth would trigger a rapid reallocation of investments—a massive stimulus program funded entirely by private capital. The objective should be to match the marginal tax rate on earned income with the effective tax rate1 on capital earnings capacity. Comprehensive tax reform centered on those changes would redistribute the burden of taxation more equitably while simultaneously stimulating economic growth and job creation.
Such a program wouldn’t be easy to sell; it would be met with inertia, self-interest among the powerful, and even potential constitutional challenges. But it is grounded in principles of equal treatment central to both democracy and capitalism and would stabilize budget deficits while stemming the rising tide of inequality. It is a true populist proposal that offers far greater potential for delivering on the promises of Trump’s campaign than tax cuts aimed primarily at the investment class.
If President Trump really wants to restore the American dream for the middle class, he needs to challenge the flawed dogma that justifies tax preferences aimed at the already privileged—and lead the tax reform debate and the economy in a fresh, more equitable, and more efficient direction.
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