Trump Gets His Tax Cuts — Now What?

tax cuts in the US

 

The Republicans finally got a win this week.

Donald Trump’s long promised tax cuts finally passed.

As usual, Trump hammed up his role as cheerleader in chief. The effort had ‘been an amazing experience’ and resulted in ‘the largest tax cut in the history of our country’.

Actually, the cuts are nowhere near the largest in US history.

Just like the President’s inauguration crowd wasn’t the biggest in history either.

But to call out Trump’s continual hyperbole in an effort to demonstrate his flaws to his supporters is to misread the reason most voted for him.

Most simply want jobs. American jobs. And they want someone who will fight to get them.

They don’t care about his personal flaws. Or grand claims. In fact, they probably love it.

Fuelled by years of ‘bad Washington’ propaganda, mostly from the Republican side, Trumps strange New York mix of outsider and right wing populist still resonates to a wide variety of people.

It’s an unusual alliance of ideological conservatives and practical working-class folk that hold Team Trump together.

And that’s who this plan is for. Or at least, that’s the theory.

While personal tax cuts to anyone but the extremely wealthy were pretty small, the big claim was that company tax cuts were going to help all.

By reducing the corporate tax rate from 35% to 21%, Trump hopes to encourage US firms to repatriate capital and invest it at home.

Around $250 billion of this could flow back into the land of the free next year.

Tax cuts appease the right wing. Increased jobs and wages appease the working class.

Everyone wins, right?

If only life was so simple…

Where’s the money coming from?

There are two glaring flaws here.

The first is to do with the US government deficit.

A country has to pay for tax cuts somehow. That’s simple maths.

Now the US deficit is already $20 trillion. And growing at $550 billion per year. It’s estimated the tax cuts could increase this by around $6 trillion.

The administration has said two things must happen for the revenue losses to be offset. One is for economic growth to generate new tax revenues.

The other way to prevent expanding the deficit is for the US Congress to find new revenues for the government by closing certain tax breaks to offset Trump’s proposed deep tax cuts for corporations, small businesses and wealthy Americans.

At least $4 trillion in new revenue needs can be raised this way, said lawmakers. But every tax break on the federal books has a special interest protecting it, and that is a challenge. 

Given the challenges Trump has had in even passing supposedly popular bills, I can’t imagine this will be easy.

The second flaw is the idea that tax cuts for the rich somehow benefit the poor. The largely discredited ‘trickle down’ economics theory.

Conservatives point to Regan’s early success in the 1980s as proof that this can spark the US economy and enrich the middle class.

But as Australian economist Saul Eslake points out, the Reagan tax-cutting experiment was in a different background.

Unemployment was 10%, there was plenty of spare productive capacity in the economy, the US national debt was less than half its current level, and the Fed was busy cutting rates.

Today it’s completely different.

US unemployment is an astonishingly low 4.1% and headline inflation has risen to 2.2%. The Fed is desperately looking for ways to raise interest rates without popping multiple bubbles in markets all over the world.

So, what is likely to happen next?

A double-edged sword

As always, the rich will probably get richer.

That’s a given.

But can the plan work to lift real wages for ordinary middle-class folk? Well, this is a double edged sword.

If it does work, then we could see interest rates move up faster than predicted.

That would mean severe falls in a number of credit related markets.

Speculative areas in the stock market are likely to fall. Bonds are likely to come under pressure, and property markets may also go quiet as buyers reassess fair value in a world of rising interest rates.

On the other hand, if the plan doesn’t work, and wages remain stagnant, we’re likely to see ballooning deficits.

It will be a simple transfer of wealth from poor to rich, by way of government debt.

This will eventually mean a drastic reduction in government services for the poor — or a complete abandoning of the fiat currency system.

After all, money continually created out of thin air to pay for things eventually becomes nothing more than Monopoly money.

But that’s an argument for another day…

In this second scenario, Trump’s battlers lose twice. They get no wage growth, and a reduction in government provided services. Yippee they say!

Perhaps there’s a positive scenario that could play out here? But I’m struggling to find what it could be.

It’s not that I think tax cuts can’t be a good thing. It’s more to do with the context and design of this particular one.

As always though, my opinion matters less than how the markets react. And I’ll be keenly watching the price action in early 2018 to see what happens next.

Ryan Dinse,
Editor, Money Morning

Ryan Dinse

Ryan Dinse

Ryan Dinse is an editor at Money Morning. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

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