A Fiscal Disappointment - Of Tax Reform & Growth Fairies

Via RealInvestmentAdvice.com,

I encourage you to take a few minutes to review my previous analysis of the effectiveness of tax cuts on the economy.

• Bull Trap – The False Promise Of Tax Cuts


• 3-Myths About Tax Cuts


• It’s The Debt, Stupid

The Committee For A Responsible Budget penned after the passage of the tax bill:

“The House approved debt-financed tax cuts based on predictions of magical economic growth that defy history and all credible analyses.

 

Tax reform should grow the economy and not add to the debt. Unfortunately, lawmakers are assuming faster economic growth will pay for that debt increase when there is no evidence it will cover more than a fraction of the tax bill’s costs.

 

The last time Congress added 10-figures worth of tax cuts to the debt in 2001, it blew a hole in the budget and helped erase our surpluses — despite claims that economic growth would cover the cost. 

 

The growth fairy did not appear then, and it would be unwise to assume she will this time around.”

Read that again.

Despite claiming to be “fiscally conservative,” what is so amazing is that Republicans are considering doing this when debt is at the highest level in history and climbing.

When the “Reagan” tax cuts of were passed, debt was less than 50% of GDP, inflation and interest rates were high and falling, and the economy was just recovering from back to back recessions. When the “Bush” tax cuts were passed, debt to GDP was only slightly higher than under Reagan but despite the tax cuts, the economy slid into a recession compounded by the “dot.com” bust.

Currently, debt is 104% of GDP — higher than any time in history, the economy has been in a 9-year expansion at the lowest rate of growth on record, and interest rates and inflation are low with the Fed hiking rates and reducing monetary support.

The situation currently is much more like Bush versus Reagan.

Lastly, despite the continuing “talking points” that “tax cuts” spur economic growth and will pay for themselves over time….there is no evidence to support that claim.

Given we are projected to borrow another $10 trillion over the coming decade. Republicans should be looking for “fiscally responsible” tax reform rather than piling another $2.2 trillion on top of it.

As the CRFB concludes:

“Instead of trickling down economic growth, the House plan will unleash a tidal wave of debt that will ultimately slow wage growth and hurt the economy.”

The market WILL figure this out eventually, and the consequences will not be good.

Congress Takes The First Step To Pass Tax Reform: Here's What Comes Next

Today The House passed the 2018 budget resolution in a 219-207 mostly party-line vote (18 republicans voted against the resolution along with all Democrats), representing the first step toward the Republican goal of sending tax-reform legislation to President Trump. Republican lawmakers hailed the vote as meaningful because the due to the budget reconciliation rules, the incorporate tax measures would allow Republicans in the Senate to pass tax reform without any Democratic votes, though Senate Majority Leader Mitch McConnell can only afford two defections (this proved to be a terminal hurdle in repealing Obamacare).

“We haven’t reformed this tax system since 1986. We need to pass this budget so we can help bring more jobs, fairer taxes and bigger paychecks for people across this country,” Speaker Paul Ryan said during House floor debate.

News of the passage provided a fresh burst of upside to the S&P which closed at fresh all time highs, driven by both tech and US-focused small-cap stocks, while the VIX dropped to new all time lows.

To be sure, for the past month, all trader eyes have been focused on the prospect of US tax legislation which has fast become the only catalyst for equity valuations, and especially following last week"s  release of the proposed Republican tax plan, as well as the failure (again) of the party’s efforts on healthcare. Additionally, the tragedy of three major hurricanes hitting Texas, Florida, and Puerto Rico has superimposed a new agenda onto Congress given the urgency of relief needs (which could also open the door to longer-term infrastructure improvements). As a result, how recovery and reconstruction may reshape the fiscal agenda —and the potential of getting it all done — is the main question Goldman asks in its latest "top of mind" periodical publication.

The question is critical because while today"s budget resolution passage suggests a beneficial tailwind far tax reform, there are many who warn that the real work, and major hurdles - not to mention bickering within the Republican party - is only just starting.

So to get a sense of the complexities that lie ahead, here is Goldman"s Washington economist Alec Phillips, laying out the next steps and assessing the prospects for the passage of both tax reform and fiscal policy, one which now faces substantial obstacles.

* * *

An update on the DC fiscal agenda

The recent fiscal deal cleared the decks…

The urgent need to provide hurricane relief funding drove the recent bipartisan deal to suspend the debt limit and extend spending authority, clearing the agenda of near-term fiscal deadlines several weeks earlier than had been expected. As a result, Congress has several more weeks before year-end to consider tax reform and other measures.

…but kicked the can.

However, this newfound breathing room won’t last long. Spending authority must be extended again by December 8 and the debt limit must be raised by late February or March 2018, when Congress is likely to be in the thick of debate on other issues like tax reform. We are not particularly worried about the risk of a shutdown in December but we do believe that the need to raise the debt limit during the final stages of the tax-reform effort poses risks for both issues.

Bipartisan cooperation could increase…

The recent fiscal deal also raised hopes for other bipartisan agreements on immigration, tax reform, and an infrastructure program. We think the chances for bipartisanship in a few areas might have indeed increased, for two reasons. First, additional hurricane funding could compel fiscal conservatives to support spending initiatives that they might otherwise oppose. Second, the positive public reaction to the recent fiscal deal might motivate the White House to pursue more discussions across the aisle.

…but is unlikely to become the norm…

There is simply not much overlap at the moment between lawmakers of each party on key issues under consideration, like healthcare or taxes. In addition, while the president has shown interest in a narrow bipartisan agreement on immigration, his core supporters appear to be strongly opposed.

…particularly where reconciliation could be used.

Republicans can use the reconciliation process to change the tax code or the Affordable Care Act (ACA) and are apt to do so if they can. While a bipartisan process could allow for a wider range of policy changes and would lead to more durable reforms, the drawback is that reaching an agreement is less likely. By contrast, an approach that relies on the majority party alone is likely to succeed even if it faces greater procedural constraints on the types of changes that can be made.

Health reform is off the agenda for now…

The recent Senate debate over healthcare legislation demonstrates that even reconciliation legislation is not guaranteed to pass. We had never expected Congress to repeal the insurance subsidies provided through the ACA, but we did expect Republicans to make changes to ACA policies either a repeal of a few politically unpopular provisions like the individual mandate, or devolution of control over the program to state governments. The Senate attempted to pass both but neither had sufficient Republican support. The most that appears possible in the near term is a set of targeted changes to improve the program for 2018. With the reconciliation strategy on healthcare put aside for now, a bipartisan agreement in this area looks possible, though with potentially modest effects.

…but might return.

Congressional Republicans might make another broader ACA repeal push at some point before the midterm election, by using the reconciliation process in either the FY18 or FY19 budget cycle. At this point, the House and Senate differ, with the House resolution instructing the committees with oversight of the ACA to pass legislation cutting spending by $72bn over the next 10 years, which could come from ACA subsidies or unrelated programs, like Medicare. In the Senate, the draft resolution includes no such instructions and would be incompatible with ACA repeal. We expect the Senate approach to prevail for FY2018, effectively pushing the next repeal/replace opportunity to mid-2018 or, more likely, 2019.

Tax reform is moving forward on two tracks…

With health legislation finally out of the way, the focus has shifted to tax reform. Congressional Republicans expect to use the reconciliation process to pass tax reform, which would require two steps: First, the House and Senate budget committees must lay the procedural groundwork with a budget resolution for FY18 that instructs the tax-writing committees to cut taxes by a certain amount, a process that is underway. Second, once a final budget resolution has passed in the House and Senate, the tax-writing committees—the House Ways and Means and Senate Finance Committees—write the detailed  tax legislation that would carry out those instructions. This must also first pass at the committee level, then the full House and Senate, and finally a conference committee to resolve any differences. In all of these votes, only a simple majority would be required because it is part of the budget process, which is governed by special rules.

…and the recent news on tax reform has been positive…

Over the last few weeks, three developments have raised the odds of tax reform, in our view. First and most importantly, a tentative agreement was struck by Senators Corker (R-Tenn.) and Toomey (R-Penn.) that allows for the FY18 Senate budget resolution—released on September 29—to include instructions to the tax-writing committees to cut taxes by up to $1.5tn over 10 years. This was a critical development since, once finalized, it would allow for a cut in tax rates with less broadening of the tax base than would be necessary under a revenue-neutral instruction, allowing lawmakers to avoid making the most politically difficult choices. Second, the framework released by the “Big Six” signals modest progress on agreeing on a single set of reforms, though the details are not yet fully formed.
Third, the public support from the House Freedom Caucus for the framework and the upcoming budget resolution suggests that its members are unlikely to be a major obstacle to enactment. While the second and third items were not particularly surprising, we believe the tentative budget agreement was likely one of the more important turning points in this debate.

…but there are still plenty of obstacles to overcome.

There are two important technical obstacles that Republicans must overcome to pass tax reform via reconciliation. First, pay-as-you-go (PAYGO) rules constrain the consideration of deficitincreasing legislation. While most of these rules can be circumvented, one that could be difficult to get around is the statutory PAYGO rule enacted in 2010, which imposes automatic spending cuts via sequestration to offset the effect of any deficit-increasing legislation Congress passes. This would not prevent Congress from passing a net tax cut, but might serve as a deterrent. Second, the “Byrd” rule in the Senate prohibits reconciliation legislation from increasing the budget deficit outside of the window covered by the budget resolution (traditionally 10 years). Waiving either rule requires 60 votes in the Senate.

A more fundamental obstacle is political.

Thin Republican majorities in the House and Senate have made it difficult to reach consensus so far this year. Tax reform needs support from 50 of 52 Senate Republicans, and we expect the 50th vote to come from the same group of centrists who were among those who recently blocked the health bill. These senators might press to keep the size of the tax cut even smaller than the $1.5tn over 10 years allowed under the Senate budget resolution. However, our expectation is that these senators are more likely to limit the size of the tax cut, rather than block the bill entirely as they did with the health bill (find a more detailed look at tax reform prospects here).

The fiscal boost from tax changes will likely be small.

Financial markets are more focused on fiscal stimulus than Congress. However, while we believe there is a 65% probability that Congress will enact tax legislation in 2018, we expect the size of the potential fiscal boost to be fairly small. The Senate budget resolution includes a tax cut placeholder of $1.5tn over 10 years; since roughly $450bn in existing tax breaks are already scheduled to expire over the next 10 years, this works out to around a $1.05tn net tax reduction. The revenue effects of the tax cut might be estimated on a “dynamic” basis, which considers the economic growth implications of the tax bill when determining its cost. Depending on whether the dynamic score is applied to the $1.5tn or the $1.05tn, this could allow for a “real world” tax cut worth 0.4-0.6% of GDP. All else equal, we expect that this would boost growth by around 0.2pp in 2018 and 2019.

Hurricane relief funding presents some upside risk.

The prospects have risen for a year-end agreement that combines hurricane relief funding, a few targeted infrastructure financing mechanisms, and an increase in the caps on defense and non-defense discretionary spending. Following similarly sized hurricanes in the past, Congress appropriated funds equal to about 60% of the total damage estimates; this suggests that Congress could approve as much as $75bn in funding for Hurricanes Harvey and Irma. The total would rise further with damages from Maria. This would not only boost federal spending directly, but could also allow for an agreement to lift the caps on other spending (emergency spending for disaster relief is exempt from the caps). While we are not particularly optimistic that an agreement will be reached on a broad infrastructure program, hurricane spending could represent a similar amount of funds going to similar types of projects.

Finally, here is the full summary of the US budget process:

"Worst Possible Choice For US Economy" - Peter Schiff Slams Plan To Repeal Debt-Ceiling

Authored by Peter Schiff via Euro Pacific Capital,

Of all the absurd Washington pantomimes none has been as reliably entertaining and maddening as the annual debates to raise the debt ceiling. Although the outcome was always a foregone conclusion (the ceiling would be raised), the excitement came when fiscal conservatives bemoaned the perils of runaway debt and “attempted” to exact spending restrictions through threats “to shut down the government,” (which often led to news coverage of tourists being turned away from national parks.) On the other side of the aisle Democrats would rail that the ceiling must be raised “because America always pays her bills.” Lost was the irony that “paying” bills with borrowed money was fiscally responsible, and that raising the ceiling actually enabled America to continue to avoid paying its bills. After these amateur theatrics, the ceiling would be lifted and Washington would go on as if nothing happened. But at least the performance threw occasional light on the nation’s debt problems.

But this week the news dropped that President Trump had made a “gentleman’s agreement” with Senate Minority Leader Chuck Schumer to permanently scrap the  “debt ceiling” so that government borrowing can occur perpetually without the need to air the nation’s fiscal dirty laundry. Given how much the national debt has exploded in recent decades, and how reluctant Congress has been to address the problem, it should be no surprise that the proposal has finally been made. The only shock is that it happening when the Republicans control the White House and both houses of Congress.

The news came just a day after the President stunned the Republican party by abruptly siding with Congressional Democrats over the best way to deal with current debt ceiling negotiations. These developments should make it clear, as I described in the weeks after Trump moved into the White House, that budget deficits during the Trump administration will be far larger than just about anyone predicted. In fact, the self-proclaimed “King of Debt” is reaching for his crown and the coronation profoundly affect the fate of the U.S. dollar and the American economy.

Trump came to the White House with essentially no history of stated aversion to government spending and debt accumulation. Instead, he won the votes of Republicans and some independents by staking out extreme positions on immigration, terrorism, and economic nationalism, and by thumbing his nose at a political establishment much deserving of ridicule. Unlike almost all other Republicans, he had nothing to say about fiscal prudence, limited government, entitlement reform, spending cuts, or balanced budgets. In fact, he very rarely criticized government for being too large, but simply for being too stupid.

But as a businessman Trump had made his successes by borrowing, and then by borrowing even bigger when his ventures fell deeply into the red. There really should have been no doubt that he would bring those instincts with him into the Oval Office.

Republicans who thought otherwise have no one but themselves to blame for what the future holds.

The debt ceiling came into existence just a few years after the Federal Reserve was created in 1913. At the time that the bank was established many politicians, and certainly many citizens, were concerned that it could potentially lend unlimited funds to the government, a capacity that could short-circuit constitutional checks and balances and lead to the development of a Federal behemoth. As a result, the Fed’s original charter prevented the bank from buying or owning obligations of the U.S. Treasury. This provision allayed the fears of unlimited borrowing and it helped Congress approve the Act.

But just a few years later the United States entered the First World War. The massive expenses associated with quickly waging war on an unprecedented scale was too much for the government’s ability to tax or borrow directly from the public. Instead Congress changed the charter to allow the Fed to buy debt from the government. But to prevent this power from being absolute, Congress set limits. This “debt ceiling” has been with us ever since. But since it has been raised so many times in the past 100 years (every time the issue has come up), the intent of the law has been essentially neutered and now appears to be an archaic vestige with no real purpose; the fiscal equivalent of an appendix.

But in reality it is much more than that. For years Republicans have paid mountains of lip service to the need for a Balanced Budget Amendment as the only way to force government to live within its means. But the existence of the Debt Ceiling had given them that power all along. Like Dorothy in the Wizard of Oz, all conservatives had to do was click their heels together three times and not vote to raise the debt ceiling. And just like that our budgets would have had to be balanced. But Republicans just like to talk about balanced budgets. They never really wanted to actually balance them.

But even the possibility helped. One of the primary reasons that annual government deficits declined by two thirds between 2010 and 2015 (from $1.4 trillion to $450 billion) was because the Republican-controlled Congress was able to get the Obama administration to agree to the so-called “sequester” which capped the level of growth in a variety of Federal programs, including social programs and the military. Absent the leverage provided by the debt ceiling, sequester never would have seen the light of day. It is clear however that most of those negotiations were political in nature: Republicans beating on a Democrat president with any club they could find. But the end result was good for the country. Now that a “Republican” is on the other end of Pennsylvania Avenue, no clubs are being sought. 

In fact, voting to raise the debt ceiling was always politically embarrassing for Republicans. To provide cover the measures were usually pared with some other politically popular legislation. In many cases some Republicans would be given the nod from leadership to vote no, as they could cast their votes against it knowing it would pass anyway. But eliminating the ceiling makes it that much easier for Republicans to campaign one way and govern another.

But the potential failure to raise the debt ceiling has never been the problem. It’s the debt that’s the problem, and the ceiling is a tool to solve the problem that vote-seeking politicians are afraid to actually use. If we eliminate the only tool, the problem will never be fixed. If the debt ceiling were to be cut out like an unneeded appendix, we should expect that America’s foray into debt creation, which has already been fantastical, to journey even farther into the looking glass. America’s funded national debt is already just a few clicks below $20 Trillion. If we were able to amass that much debt with a ceiling, even one that could be raised, imagine how much more debt will be run up with no ceiling at all!

In the end we may be able to repeal our self-imposed debt ceiling, but our creditors may not care.

When we drop even the pretense of a theoretic limit to our profligacy, our lenders may decide its time to impose a lending ceiling of their own. That is a ceiling we have no power to raise, and it could force our leaders to finally make some very unpopular choices. Massive cuts to government spending, including to current Social Security and Medicare benefits, huge middle class tax hikes, or an actual default on the national debt. Since neither of these alternatives is politically viable, I believe the coward’s way out will be a massive QE program where the Fed buys the bonds our creditors no longer want. This could be the worst possible choice for the U.S. economy, and investors should be prepared.

It could produce a dollar and sovereign debt crisis that will dwarf the financial crisis of 2008 with respect to its impact on the American economy. It could make hurricane Irma look like a sun shower.

Ron Paul Asks "Will Trump Continue The Bush-Obama 'Big Spending' Legacy?"

Submitted by Ron Paul via The Ron Paul Institute for Peace & Prosperity,

This week, Congress passed a budget calling for increasing federal spending and adding $1.7 trillion to the national debt over the next ten years. Most so-called “fiscal conservatives" voted for this big-spending budget because it allows Congress to repeal some parts of Obamacare via “reconciliation." As important as it is to repeal Obamacare, it does not justify increasing spending and debt.

It is disappointing, but not surprising, that the Obamacare repeal would be used to justify increasing spending. Despite sequestration’s minor (and largely phony) spending cuts, federal spending has increased every year since Republicans took control of the House of Representatives. Some will attribute this to the fact that the Republican House had to negotiate with a big-spending Democratic president — even though federal spending actually increased by a greater percentage the last time Republicans controlled the White House and Congress than it did under President Obama.

The history of massive spending increases under unified Republican control of government is likely to repeat itself. During the presidential campaign, President-elect Donald Trump came out against reducing spending on “entitlements.” He also called for a variety of spending increases, including spending one trillion dollars on infrastructure.

One positive part of the infrastructure proposals is their use of tax credits to encourage private sector investments. Hopefully this will be the first step toward returning responsibility for building and maintaining our nation’s infrastructure to the private sector.

Unfortunately, the administration appears likely to support increased federal spending on “shovel-ready” jobs. Claims that federal spending helps grow the economy rely on the fallacy of that which is not seen. While everyone sees the jobs and economic growth created by government infrastructure projects, no one sees the greater number of jobs that could have been created had the government not taken the resources out of the hands of private businesses, investors, and entrepreneurs. Despite what some conservatives seem to think, this fallacy applies equally to Republican and Democrat spending.

President-elect Trump has criticized the past two administrations’ reckless foreign policy, and he has publicly shamed the powerful Lockheed Martin company for wasting taxpayer money. Yet, he continues to support increasing the military budget and has called for increased military intervention in the Middle East.

The fact is the United States already spends too much on militarism. Not only does the United States spend more on the military than the combined military budgets of the next eight highest spending countries, but Pentagon waste exceeds the total Russian military budget.

America can no longer afford to waste trillions of dollars on a militaristic foreign policy. Donald Trump should follow-up his attacks on wasteful military spending by dramatically changing our foreign policy and working to cut the Pentagon"s bloated budget.

If the new administration and Congress increase spending, they will need the Federal Reserve to monetize the growing debt. The need for an accommodative monetary policy gives the Federal Reserve and its allies in Congress and in the deep state leverage over the administration. This leverage could be used, for example, to pressure the administration to abandon support for the Audit the Fed legislation.

Fed action can only delay the inevitable day of reckoning. Raising levels of federal spending and debt will inevitably lead to a major economic crisis. This crisis is likely to be reached when concerns over our national debt cause more countries to reject the dollar’s status as the world"s reserve currency. The only way to avoid this crisis is to stop increasing spending and instead begin reducing spending on all aspects of the welfare-warfare state.