The Trump Effect: Market Implications of Conservative Economic Policy

Introduction

The surprise Trump Victory has impacted financial markets globally. As the status quo is disrupted, one can only assume chaos. A precedence to massive change is always chaos. The question is: How will this change impact our economy, ideology and the world?

We seek to analyze this impact through analysis of key economic indicators. Additionally, we seek to determine whether solutions to maintaining a vibrant and fiscally responsible economy are ethically moral given today’s social constructs.

Firstly, I’d like to analyze Trump’s overall Economic Plan, one of the largest factors that can influence the US and Global Economy. As we enter into an era with the slowest economic recovery since the Great Depression, we have begun to see economic indicators that have indicated an almost full recovery.

Even with a real estate and stock market at record levels, a large degree of insecurity still exists. Consumer sentiment has left lasting impressions on citizens whom of which have not recovered from losses obtained during the mortgage crisis of 2007. The graph below represents consumer sentiment from the Great Recession — present. As can be seen, there has been a slow recovery, with levels still lower than 2007 levels.

Figure 1: Change in American Consumer Confidence Since the Great Recession [2]

The tax policy center estimates a Trump Tax plan proposal would reduce Federal revenues by $9.5 trillion over its first decade and an additional 15 trillion over the subsequent 10 years, before accounting for added interest costs or considering macroeconomic feedback effects. A large portion of the revenue loss would come from individual income tax cuts, however 1/3 would be from the reduction in the corporate income tax rate and introduction of special rates on pass through businesses [1].

It is my belief that the significant cuts in marginal tax rate would boost incentives to work, save and invest if interest rates remain unchanged. There is potential for an increase in Federal borrowing to push up interest rates and crowd out private investment, providing a lack of clarity as to the overall net effect on the US economy. [1]

On the inverse; as capital available for private investment increases, interest rates tend to decrease to combat idle funds. This can be considered the opposite of the crowding out effect. A reversal of corporate inversion through significant tax decreases has the potential to counteract this threat by flooding US capital markets with offshore held capital.

Let’s analyze the elements of President Donald Trump’s plan; and when I say plan I mean that unlike traditional politicians: it is completely malleable. I see this as positive to our economy, as malleability is one of the best approaches to combating ever changing scenarios. The following are bullet points of the key elements in his proposal:

Individual Income Tax [1]

(1) Collapse the current seven tax brackets, which range from 10% to 39.6%, into three brackets of 10%, 20%, and 25%.

(2) Increase the standard deduction to $25,000 for single filers and $50,000 for joint filers in 2015, indexed for inflation thereafter

(3) Leave personal exemptions unchanged at $4,000 per person in 2015, indexed

(4) Tax dividends and capital gains at a maximum rate of 20 percent

(5) Limit the tax value of itemized deductions (other than charitable contributions and mortgage interest) and exclusions for employer — provided health insurance and tax-exempt interest (Increase the phase out rates for the personal exemption phase out and the limit on itemized deductions

(6) Repeal the alternative minimum tax

(7) Tax carried interest as ordinary business income

(8) Repeal the exclusion for investment income on life insurance contracts entered into after 2016

(9) Repeal Federal Estate and Gift Income Tax

Business Tax [1]

(1) Reduce the corporate tax rate to 15%

(2) Limit the top individual income tax on pass-through businesses such as partnerships to no more than 15%

(3) Repeal most tax brackets for businesses

(4) Repeal the corporate alternative minimum tax

(5) Impose up to a 10% deemed repatriation tax on the accumulated profits of foreign subsidiaries of US companies of the effective date of the proposal, payable over 10 years

(6) Tax future profits of foreign subsidiaries of US companies each year as the profits are earned

Affordable Care Act Taxes [1]

(1) Repeal 3.8% net investment income tax on high-income (single filers with income over $200,000 and couples with income over $250,000, unindexed

Below is a chart that reflects the change on current tax code with the implementation of a Trump tax code. As can be seen from the chart, the largest percentage reduction is in the largest .1% of income tax payers, average more than $1.3 million in 2017.

Figure 2: Trump Income Tax Code [1]

Additionally, The Donald seeks to implement extensive immigration policy as a measure to combat Radical Islamic Terrorism, particularly the growing rise of ISIS in the Middle East and subsequent Syrian migrants at risk of ISIS infiltrations. This is understandable, as sentiments have fell to pre-911 levels while at the same time Islamic Terrorism is at its highest levels. Such policies include:

(1) Build a “Wall” on the Mexican border to fight illegal immigrant workers coming from Mexico.

(2) He seeks to tighten drug flow from Mexican cartels to combat both the highest murder rates in over 50 years; as well as combat drug involvement that encompasses it and the severe addictions to heroin and opioids that have crippled poor youth communities and families.

(3) Release drug offending illegal immigrants and non-citizens to home countries, creating a reduction in fiscal spending by the Federal government.

(4) He intends to implement extreme vetting as an element to combat radical Islam

(5) He wants to make an Alliance with Russia to help fight radical Islam in order to reduce US governmental spending. He additionally hopes to reduce funding for NATO, assuming he feels the alliance with Russia will reduce the need to be the dominant financial provider of its allies.

As a supporting statement, the fundamental elements to a vibrant economy are private property rights, peace, protection, security and stability. Terrorism and international treats heavily affect consumer confidence and financial markets, which can be considered a major engine of growth and prosperity for our economy. I expect Trump’s foreign policy measures to result in future stability and unity with key opposing nations such as Russia.

Now I would like to list the current state of our economy and some important clarifications.

Our current Debt to GDP ratio is 75%, with debt as a portion of GDP at 2.9%, expected to rise to 5% by 2027. This is due to the aging of the baby boomer class, with increased financial care required. The population 65 + is expected to rise 34% over the next decade, whereas the working population is expected to rise 2%. This accounts for almost all of the increase in governmental spending.

We now face a dilemma of how to handle the debt load in order to avoid financial implications on the private US economy. It is my belief that the primary focus is to service the national debt, with the intent to lower spending and increase government revenue through economic growth in order to eventually begin principle payments on our current deficit.

Firstly, the causal relationship between how much a government deficit can impact a private economy has been a continuous debate amongst economists. What we do know is that over stimulus by government creates a very large and often inefficient budget. Secondly, the in order for the Federal deficit to significantly impact the US economy, the government would need to default on the maintenance of debt, or rather interest payments. Below is a chart that reflects the net impact of a Trump Tax plan on Federal receipts.

Figure 3: Trump Tax Plan Implications on Federal Receipts [1]

The governmental spending increases that have been made by Obama have resulted in over doubling the national deficit, and in our current case to around $20T. Nonetheless, a crowding out effect has already occurred over the last decade, with government spending continuously as a larger proportion of the total capital available for investment.

This has resulted in less capital available for the use of private investment, resulting in severe corporate inversion. In the case of the Trump Plan, as can be seen from the graph above, over $1T needs to be cut from the Federal budget in order to accommodate reduction in tax receipts, before any macro-economic effects.

It is an economic principle that reduction in taxes can potentially increase tax receipts, as more businesses feel optimistic about economic prospects and invest in small businesses or educate themselves to enter into the workforce. Additionally, low income tax increases disposable income. As consumer confidence, disposable income and incomes from inflation increase; a wealth effect is created. A multiplier effect on the economy, GDP and Federal income receipts is created, which can potentially increase annual GDP growth by a significant amount from current levels.

As can be seen from the graft below; throughout history we have seen a significant increase in Federal receipts from income tax and a continuous decrease in corporate tax receipts. This is congruent with the significant amount of corporate inversion seen, beginning in the mid 1970’s. We can also see the correlation with globalization begging after WWII. While although we have entered into “The Great Experiment”, I understand that history has a way or repeating itself.

Figure 4: 1935-Present Federal Income as a % of Total Receipts

Now in order to understand whether Trumps specific agenda will achieve an equilibrium state of maximized GDP growth; as an optimist argument I would like to indicate a couple of elements. Inflation has the potential to increase stagnated wages, increase taxable income and create a wealth effect in our economy, which in turn boosts consumer confidence and tax receipts. The graph below represents the global deflationary cycle we are currently exiting.

Figure 4: US Inflationary Cycles 1962-Present

It is my belief that given all economic metrics, we have just begun to start raising consumer confidence and inflation to levels that can restart our country’s engine of growth. Assuming “The Donald” can cut spending to offset the reduction in taxes, the resulting stimulus of both capital investment, consumer confidence, inflation and job opportunity has the potential to offset deficits. It is my belief that interest rates will remain low, as the massive influx in capital will force central banks to lower rates. This is a mutual interest, as they intend to keep interest payments low to service debt. In addition, it can be assumed that the influx in capital can create a stronger domestic bond market, resulting in a larger portion of Federal financing from domestic investors. This has been seen with Japan, as their economy currently has maintained debt to GDP ratios of over 200%. A domestic creditor market creates stability as debt is owned by citizens and not foreign investors.

The question is: Where do we cut spending? I believe there are massive efficiency cuts to be had with the government, as everyone has heard about the $500 hammer the government has to pay for. Secondly, our country has spent over $3T-$5T in the Middle East, rebuilding their infrastructure.

As we have a crippling infrastructure, one can believe that through diplomacy with our traditional enemies, we can increase stability without having to fund every war effort. As military accounts for a large portion of our total federal budget, with 2015 totaling $534B. This is larger than the 10 next countries combined, with 9 of the countries currently as our allies. I believe there is much room for efficiency.

Through defunding NATO and developing peace with Russia, I believe we can see a margin for significantly reducing military expenditure. Secondly, it is understood that the baby boomers will have a significant financial burdon on the Federal budget. One of the elements to reducing healthcare costs is through the breakup of oligopolies which hike up health care rates.

If the Trump Administration can eliminate the invisible barriers surrounding each state, I believe private healthcare can become significantly less expensive. Furthermore, a reduction in regulation has potential to reduce both primary and second round costs associated with the government.

Lastly, as there is a morality question at hand, how can we expect the Trump Administration to be able to fund care for our elders and provide opportunities for underprivileged youth? If we assume massive military cuts and an elimination of the Affordable Care Act, it is my belief that we abolish Social Security and elderly entitlements after a certain age at, let’s say, 30.

I am perfectly okay with paying for the older generation, and understand that my social security payments will not be returned. I don’t believe any millennial is expecting to receive such payments anyways. If we can keep funds fueled into Social Security, with enough reductions we can absolutely see prosperity and a shrinking deficit. It will have to be made up in economic growth, however.

As underprivileged youth is an additional element of discussion, I believe that the massive drug influx from Mexico has caused a severe heroin epidemic. This has crippled our youth and unmotivated them to become productive members of society. Federal funding doesn’t necessarily equal positive outcomes, which are often times due to drugs. This can be seen from the drug dealers who live in my apartment building while receiving Section 8 HUD checks. Ironic.

From my understanding, our country’s ideological set is so subjective, that in one light a certain demographic believes something is immoral, while for another it is noble and patriotic. Therefore, I believe in the individualistic and entrepreneurial roots of our country as the foundational ideological set to which we attribute our success and ideology as a nation. I do not prescribe to the collectivism mindset that has been proven throughout history to decrease productivity and create dependency on our government. A larger and larger government is a topic of which our forefathers warned us. Do we really want a “Big Brother” society?

Conclusions

The Trump plan would require spending cuts to avoid adding to the federal debt. We estimate that the plan would require reducing spending by $1.1trillion per year until 2025. The Congressional Budget Office projects total noninterest outlays in 2025 of about $5.3trillion. The Federal budget would need to be cut by 21 percent to prevent the plan from adding to the deficit in 2025. [1]

If we analyze the countries budget, the majority of our spending is allocated to Defense, Social Security and major Health Programs. If policy can reduce insurance and healthcare costs to levels seen in Europe, we will see a major benefit to our Federal budgetary obligations. Furthermore, with diplomacy we can see a major reduction in Defense spending without compensating national security.

Assuming Donald Trump can trim the fat and reduce our Federal budget by $1.1T through military efficiency, welfare reform, and Obama Care repeal; he needs to provide a climate for higher inflation to raise incomes and increase consumer confidence.

Mr. Trump’s tax reform plan would boost incentives to work, save, and invest, and has the potential to simplify the tax code. By lowering marginal tax rates and limiting or repealing many tax expenses, it would reduce the incentives and opportunities to engage in wasteful tax avoidance and would provide more transparency in corporate and individual financials.

The proposal would cut taxes on households at every income level, but much more as a share of income at the top 1%. This would result in a larger amount of disposable income that can increase consumption as an endogenous variable. The fundamental concern the plan poses is that large cuts in government tax revenue is likely to create a major budget deficit. [1] The optimists have the market however and I believe growth and independence can bring about a Renaissance of American prosperity while keeping true to our ideological values of individualism, entrepreneurship and caring for under privileged youth.

John Walsh: Independent Analyst

[1] http://www.taxpolicycenter.org/publications/analysis-donald-trumps-tax-plan/full

[2] https://data.oecd.org/leadind/consumer-confidence-index-cci.htm

[3] http://www.forbes.com/sites/mikepatton/2015/10/31/a-brief-history-of-the-individual-and-corporate-income-tax/#7089410c30ba

[4] https://data.oecd.org/price/inflation-forecast.htm#indicator-chart