Please don't tell us you're still using the Laffer Curve, Mr Mnuchin...

Friday 29th September 2017

  

Please don't tell us you're still using the Laffer Curve, Mr Mnuchin ....

ref :- " Most Economists Agree : Trump Tax Plan Will Widen Budget Deficit" , Bloomberg Markets

It's Friday ..... whose got the energy to go into President Trump's tax plans announced on Wednesday ? Come to that, whose got the inclination, given that it would take all weekend ? We should however offer a few general observations with markets in mind.

Although they're taking a small breather this morning, stock markets have mostly reacted favourably to Mr Trump's speech ..... as well they might. Just to pick out a few headlines, a reduction in corporation tax from 35% to 20% would plainly be beneficial for corporate earnings and for growth. So too the temporary tax break on corporate capital expenditure that could be expected to increase investment and prospects for future growth (though some see its temporary nature likely to foster only a short-term boost  --  the so-called "Sugar Rush"). The reduction of the number of different tax codes from 7 down to 3 (12%, 25% and 35%) has also been welcomed (there is an option of a 4th higher rate for the very wealthy if tax-writing committees see fit) .

Bond prices were already somewhat on the defensive (which is to say, bond yields on the rise) after recent hawkish jawboning from Janet Yellen and other Fed bigwigs, but rising expectations for growth and rates implied by the proposals have  added to the selling pressure. Moreover, whatever your view on what it means for the levels of public borrowing required to finance these tax cuts  --  more of which in a moment  --  it's hard to argue that there won't be some extra burrowing needed in the short-term at least.  And of course the Dollar was able to continue its minor recovery (for a while) on the back of those same upward implications for growth and rates.

If the immediate market reactions were logical enough, it's fair to say that time is giving investors a chance to take a more considered view of the tax proposals. Not for the first time with this administration, there's a frustrating lack of detail to the plans. In fact, more accurately they should be called a "framework" rather than "plans". Just for example, the 3 (or 4) new tax bands are all very well, but there's no clue as yet about what levels of income they would be applied to. There are many questions that have been raised but not answered, but the most important for the chances of these proposals passing into law is just how the rate cuts are going to be offset by additional revenue.

Treasury Secretary Steven Mnuchin yesterday set out his belief that the programme will in fact slash budget deficits by spurring faster economic growth, which will in turn generate a larger Federal take  ---  in essence, the government will take tax at a lower rate but from a much bigger pie and .... nett nett nett .... will be better off. Sound familiar ? It should do ..... it's a simplified interpretation of the Laffer Curve theory of course, and we've been here before.

Mr Mnuchin is obviously a subscriber to the theory ...... which is interesting because in the eyes of many (most ?) economists it's been discredited. Arthur Laffer's Curve, sketched on the back of a napkin to illustrate the principle to Dick Cheney and Donald Rumsfeld back in 1974, is one of those things that sounds IN THEORY as though it might work, and indeed many people hoping for easier tax regimes might hope that it would. Historical evidence though suggests pretty emphatically that it doesn't. And if the decision-makers needed another reason to think twice before getting too closely associated with such thinking, along with "trickle-down economics" perceptions of a right-wing bias that favours the wealthy at the expense of the needy make it a political minefield. Well, old Arthur is something of a reactionary ....

Undeterred, Mr Mnuchin said yesterday that not only will the Trump tax plan pay for itself, but will actually reduce the budget deficit by $1 trillion over the next 10 years (taking annual growth rates of 2.9%) . Needless to say, not everybody agrees. The Committee for a Responsible Federal Budget reckon that the deficit will actually be swollen by an extra $2.2 trillion over 10 years, and in predicting a widening of the deficit they are in agreement with 21 of 26 economists surveyed by Bloomberg.

And therein lies a big problem with what has become a flagship issue for this administration. For all the generally good reception given to certain elements of the proposals, particularly to those promoting growth, it looks like it will be real struggle to get them passed into law  --  in anything like its current form, at least (whatever that may turn out to be). Despite Mr Trump's assertion that this is a "miracle for the middle class", the plan will almost certainly be seen as most beneficial to the wealthy whilst effectively ignoring the poor. As such, as it stands it won't attract support from the Democrats. And the fiscal hawks in Mr Trump's own party are not likely to give the nod to measures that swell the budget deficit (remember, the Congressional Budget office was already forecasting a rise of $10 trillion in federal debt over the next decade before the tax plan). They are also unhappy that one of the measures put forward to actually save money, repealing breaks on state and local taxes, will hurt Republican voters in key, high-tax states like New York.

In short, one has to think that whatever eventually passes through Congress will be very different to the plan that Mr Trump envisaged. Senator Bob Corker, himself a veteran fiscal hawk, has said that getting this thing through will be worse than the failed attempts at repealing healthcare legislation. If that's true, and again not for the first time, one probably shouldn't be making any longer-term trading decisions on the back of what this administration SAYS it's going to do.