Tax policy plays a major role in the incoming administration’s plans to boost the U.S. economy in 2017 and beyond, but they’ll need to pursue it carefully, according to Joe Brusuelas, chief economist at Top 5 Firm RSM US.
“We’re either going to look back on 2017 as the year the American economy achieved what I call ‘strategic breakout,’” he told Accounting Today in an interview, “or the year in which we started down the road toward a more profound day of reckoning with respect to our budgets and our date.”
“The new administration intends to use expansionary fiscal policy to stimulate the economy in the hope of lifting productivity and creating a quicker pace of growth and improved long-term trend,” he explained. “What we’re going to be looking at is a fairly significant tax cut, with comprehensive tax reform across the board, in addition to increased outlays on defense, followed by a significant long-term infrastructure spending project.”
The first stage
Brusuelas expects the Trump administration to pass tax reform along the lines of Speaker of the House Paul Ryan’s “Better Way” package – including reducing the number of individual tax brackets to three and lowering rates, and lowering the corporate tax rate to somewhere between 15 and 20 percent.
“If they pass tax reform, I expect it adds about 250 basis points to growth over a three-year period, so we move from the current 1.6 percent to somewhere around 2.5 percent,” Brusuelas predicted.
However, relying on tax cuts alone can be problematic, he warned. “It’s absolutely critical that the administration get it right. The risks are that, if they just cut taxes and it provides a three-year sugar high and then they fall back to 2 percent growth, then we’re going to have some budget issues on the other side of it. The annual operating deficits are going to double from the current 3 percent to 6 percent within 24 months. This will occur unless there is a significant increase in tax revenues associated with other reforms to the tax system. There’s no sign of that yet – there’s just talk.”
To avoid the crash that usually follows a sugar high, Brusuelas said that the administration will have to pursue a deeper tax reform: “What’s going to have to be put together is a proper policy mix that provides the correct incentives for our large firms to begin making capital expenditures and investments again. We’re severely deficient -- as a percentage of GDP, it peaked in 2013 and has been falling, and we never even got to the previous expansionary peaks. It’s been that weak.”
“It’s just the tax treatment of capital,” he continued. “Lowering the corporate tax rate to 15 percent is a good start. That’s essentially a 30 percent tax cut for many firms. In terms of overall activity, the two upper quintiles of income earners are going to get a $1.8 trillion tax cut; on average, those households will observe a 13.5 percent after-tax increase in their income.”
Predictability and permanence are important, he explained: “The key is to make sure that the tax cut is permanent, and doesn’t expire. That will require 60 votes in the Senate. The most efficient tax cut is one that permanently alters expectations. In that sense, it seems to me that the efforts by the Speaker of the House to craft a bill that can get 60 votes in the Senate are absolutely critical.”
That, he said, is a lesson Republicans learned from George W. Bush’s administration about the impact on spending from tax cuts that expire: “Essentially, if you’re going to cut my taxes by a significant amount, and I know that in five or 10 years it’s going to expire, do you know how much of that I’m going to spend? Zero.”
No more ‘shovel-ready’
The other major portion of the Trump administration’s economy-boosting plans will involve infrastructure spending. These will include a mix of what Brusuelas calls “little-i infrastructure” and “big-i infrastructure.” The former is roads, bridges, ports, water and sewage systems and all the other public goods that governments generally build and maintain, while the latter involves gas and oil pipelines, energy infrastructure, and communications grids and infrastructure, where private companies can be incentivized to build it themselves or partner on it.
He expects the government to put together an infrastructure bank, funded by $50 billion in spending over a five-year period for $250 billion, which would then be leveraged up four- or five-to-one to create a trillion-dollar infrastructure project.
“It’s really important that they make good choices when it comes to the infrastructure project,” he warned. “The term ‘shovel-ready’ should never be uttered again, and anybody in Washington who does should be politely shunned. My sense is that the Senate Finance Committee in particular is going to require fairly rigorous quantification on what should be built, the bonds that are going to be issued, and the return on investment. I think that we’re going to see a lot more toll roads, to help pay for that. I’m expecting that the repatriation of the $2.6 trillion held abroad in profits will have strings attached to it, in an attempt by the federal government to direct that capital into productive uses, and the government is actively considering issuing 50-year debt, which would be new.”
If an infrastructure bill along the lines he described is passed, he expects that it would add approximately 80 basis points to growth over the next three to five years.
Beyond a hundred days
Getting all of this enacted and in place will require serious work – and it won’t happen right away.
“We’re not expecting much to get done in the first 100 days,” Brusuelas said. Congressional research acts and rolling back regulation on areas like the energy and financial services sectors through presidential directives will occupy some of that period. “Most of the first three months of the term will be taken up with the hearings over the Supreme Court nominee, which we’ve been told will be appointed by the end of the first week of the administration. I expect the first budget to be passed in May or June, and the second one in August. That will take up most of the first year. They’re actually planning to work five-day workweeks, 10 hours a day, no April recess, no early summer resource. They’re planning to go all the way to July 4.”
The first budget is expected to wrap up leftover business from the 114th Congress, and is where the Affordable Care Act will be repealed, Brusuelas said, though not necessarily replaced. “The second budget will be the one that contains the comprehensive tax reform, which may be accompanied by the infrastructure project, but not necessarily,” he said.
He doesn’t expect the Dodd-Frank Act to be repealed, but the Volker Rule, which prohibits banks from trading with their own money, will likely go unenforced.
Brusuelas expects the first half of the year to exhibit sub-2 percent growth, picking up to 2.5 percent in the second half. Unemployment should be low, and he expects job creation to slow as well – though largely because the country is at full employment, and the labor market is very tight. He thinks consumer spending will remain reasonable, and noted that household balance sheets are generally in good shape.
“The primary economic risks are external,” he said. In the short term, they come from political risk in Europe, and in the mid-term, from financial conditions in Europe and China – specifically, the health of their banking systems. (He believes the U.S. banking system, by contrast, is healthy, has healed its balance sheets, and has strong capital buffers to face any potential crisis.)
Domestically, he suggested that risks might arise from subprime lending, and the resetting of “vintage” commercial real estate loans from 2007-2008, which are due to be rolled over at higher interest rates.
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