Trumponomics: Reganomics Without the Dividend
The equity markets have caught a bid while the bond market falls on fears of the return of inflation. Any why not? In the interest of equality, Trump aims to combine the push of supply side economics with the pull of Keynesian demand stimulus. It’s hard to find a non-war period that has ever received so much support as that promised by the new President, no less at a time with historically low unemployment. It is of no surprise that the speculative equity markets would see the opportunity and the staid bond market the risk.
Supplying Demand. President-elect Trump has offered supply-side economics that echoes a more prosperous time: income tax cuts, corporate tax cuts, repatriation of overseas profits, and reduced government and regulation. These plans echo the advice that Laffer gave Reagan thirty-six years ago; however, the US and the world is a little different from the time when America was last great.
The challenge this time is that the composition of the economy is more services than goods, technology companies serve global markets not national, and the nature of US trade balance is materially different. Supply-side economics had a few difficult decades; however, even if there is credible evidence to show its value, the policies face an unalterable headwind: demographics. While the myopic markets focus on the present, there are real risks to his strategy to those willing to look further ahead.
Taxing Value. Lower taxes are, of course, preferred to higher; however, like the astute business manager understands the question is not of price, but of the value received. There are strong arguments that income taxes provide public goods that benefit everyone even though they may not be willing to pay for them directly. With many people paying more payroll taxes than income taxes, the value proposition is quite clear: health care and income during retirement.
The question of income taxes is not just the value proposition but also includes who pays and how much they pay. The answer to this question is just a public policy choice on redistribution. Trump’s income tax cuts would materially reduce the amount of tax collected with the benefits primarily accruing to the upper-income levels with the hopes that this would trickle down through more spending in the economy. As every studied economist knows, the propensity to spend decreases with higher income levels. You can only spend so much on food, clothing, and housing after which the marginal dollar becomes irrelevant and is just invested, and probably outside of the US.
Capital Supply. To help corporations deal with the expected demand boom from the increased spending, Trump argues that it is beneficial to reduce the tax burden on businesses so that they have sufficient capital to meet demand. The critical question, however, is whether supply or capital is currently constrained. The data suggests surplus capacity, people, and capital. Thus, any tax reduction will increase the return on capital.
A higher return on capital is not necessarily an unwanted outcome, but when growth is the objective, it appears unfocused. The goal of tax policy is to grow the economy, not divide the pie differently. Laffer´s Curve argued that tax cuts always lead to more growth, jobs, and income. Notwithstanding the last few decades of evidence, Kansas and California show that altering current levels of corporate taxation are not drivers of growth.
Cash Arbitrage. An argument against increasing capital is that companies currently have an excess of cash, a large part held outside the country, which avoids taxation until repatriated. As an inducement to return this capital to the United States, Trump argues for providing a little tax break for returning this capital. As before with cuts to corporate taxes, it´s not clear that this will result in higher capital investment or employment levels since corporations do not lack access to capital.
In fact, there are definite benefits to keeping the cash outside the country, as they can borrow against the cash at low-interest rates, receive a tax deduction on the interest, and earn an excess return on the invested capital. It´s hard to make a case for returning the money as an economic decision: the tax incentive would likely require payment to the company for them to repatriate their foreign profits, a wholly unlikely outcome.
Regulating Growth. Reducing the burden of regulation on corporation indeed could lower the cost structure and result in higher return on capital for them. It´s not clear, however, that this action would increase employment or output. If fewer workers are needed to meet the regulatory burden, then the excess income should be shared with the workers: this has not been the recent experience of the US. It is not obvious that reducing the number of middle-income jobs that populate the service based US economy will improve growth.
Reduced regulation, when viewed as a brand, may lead to lower consumer confidence in products and result in higher search costs. Lower demand and higher costs generally result in lower productivity. While there is an argument for expanding consumer choice, it seems less than ideal when there is asymmetric information, and something less than fully informed consumers. Realistically, most consumers would not want to inspect Hardee´s before they order their food. This action would not only slow demand and waste time but be glaringly inefficient were thousands of customers to do it.
Strategy Risk. Providing reduced regulation will unquestionably result in a higher return on capital. The challenge is the impact on growth, and the economy is debatable. Incentives, including tax incentives, are generally helpful for decision making. The critical question is whether the expected growth from these policies outweighs the reduced employment and societal cost? If growth is the objective, then it is preferable to expand the public good of education, which is the foundation of growth. In the absence of clear economic benefits, the strategic risks of supply side economics include lower employment, higher deficits, and reduced supply of public goods.
This is the first article in a two-part series on Trumponomics.