U.S. STRATEGY OF TAX CUTTING GETS A SOBERING REALITY CHECK
David Rosenberg says there will be a price to pay for relief package’s borrowed money.
Once again, I cannot believe what I hear sometimes. The other day, I think it was Tuesday in the wee hours of the morn, a market pundit on CNBC emphatically said fiscal deficits don’t matter. He went on to say they don’t matter till they matter. Then I heard another economist talk about “fiscal tailwinds,” as if that’s something to boast about.
There is no doubt the United States needed to undergo corporate tax reform, end the costly inversions and put the system on a far more competitive footing. Top marginal rates were cut, but the loopholes never were addressed and, on top of that, personal taxes were cut as well.
Why would anyone think this is a good strategy for an economy running at full employment, with the Federal Reserve raising the cost of borrowing and P/E multiples at levels that had already taken out the 2007 bubble peak?
Some folks believe it was going to boost business investment, but the corporate sector prior to the tax relief was not exactly constrained by income or liquidity. It was flush with cash. This is why the only real boom is in share buybacks. Fiscal policy today is used as a tool to make equities even more expensive than they already were.
The move to cut personal taxes, likely the most regressive package ever, which has only served to widen already record levels of income inequality, was equally egregious. But who’s going to complain, right? It gave a brief boost to disposable incomes in the first quarter, followed, with a lag, by a rare four-per-cent burst of real consumer spending growth in the second quarter. But that’s all she wrote.
We are left with a mountain of debt that still has to be serviced: a perpetual drain on the public purse long after the peak effect on conspicuous consumption.
Some will say that the U.S. economy is overtaxed. But how can that be the case with its deficit approaching, and then set to pierce, US$1 trillion?
At this late stage of the cycle, at full employment, the fiscal situation should be at or near balanced. Instead, the U.S. is posting fiscal shortfalls that in the past were reserved for recessions. If Uncle Sam taxes too much, then by definition it spends too much. But there was no appetite, even by the alleged GOP conservatives, to attack spending as they went on this tax-cutting spree.
The entire tax relief package is on borrowed money, and there will be a price to pay. If deficit financing at a time of full employment and record public debts was such a bright idea, I’m sure every country in the world would do it. The only modernday example is Japan, and it hasn’t exactly worked out too well for them over the years.
“In the last three years, Congress has passed bills that raised the discretionary spending caps, completely undermined the spending caps, reversed Medicare cost controls and reduced revenues without cutting spending.”
This little ditty is from Paul Winfree, who served last year as a budget adviser to President Donald Trump and is now at the Heritage Foundation.
Indeed, we did some work on this on our own as the U.S. follows the likes of Italy in crossing over the magical government debt-to- GDP ratio of 100 per cent. Inevitably, once the sugar high is done, the debt puts a stranglehold on economic growth.
On average, real annual GDP growth for Organisation for Economic Co-operation and Development countries in the years prior to crossing above the 100-per-cent debt ratio was 2.6 per cent. In the years after crossing that threshold, growth has averaged just 1.4 per cent.
As everyone absolutely gushes over the 4.1-per-cent annualized real GDP growth rate in the second quarter, a dose of reality seems to be required. Just because this was Trump’s first “four-handle,” it was actually the fifth of the expansion to date. I really do not recall Barack Obama running around tweeting and bragging about what a great job he was doing for an economy that was basically sclerotic despite the odd quarterly blip in growth.
What is not often stated is that it was also Trump’s first quarter of anything better than three-per-cent GDP growth at an annual rate, whereas Obama, despite all his stifling regulatory measures, managed to have no fewer than 11 of these occur under his tenure. That’s a fact, not an opinion.
At the same time, there is precious little commentary on just how disappointing a 4.1-per-cent growth rate is in the context of such large-scale governmentinduced stimulus. In the past, such a shot of adrenalin from Uncle Sam saw real GDP growth accelerate to a 5.5-per-cent annual rate.
No doubt the economy is still beset by constraints such as aging demographics, but the reality is that fiscal stimulus at such gargantuan levels of public debt ultimately faces the consequences of what is known in economic parlance as the law of diminishing returns. It is truly a pity that a president with such limited knowledge of economics decided to form a cabinet with even less expertise in this area.
Which now brings me to a must-must read: The Current Economic Recession: How Long, How Deep, and How Different From the Past? by Marc Labonte and Gail Makinen at the Government and Finance Division at The Library of Congress.
It’s a truly great compilation of research detailing the causes of each recession in the postwar era and how we got out of them. Interestingly, it was published on January 10, 2002 (the recession had actually ended two months prior, but it didn’t feel like it for at least another year).
The most pertinent comparison, for today’s purposes, was the 1969-70 recession:
“The 1969-70 recession was preceded by a period of unsustainable growth that led to accelerating inflation, which rose from 3.1 per cent in 1967 to 4.3 per cent in 1968, 4.9 per cent in 1969, and 5.3 per cent in 1970. Many contemporary observers attributed this boom and bust pattern to the fiscal policy stance at the time. As a percentage of GDP, the actual budget deficit rose from 2.6 per cent to 3.5 per cent. During a period of full employment, this increase in the deficit is likely to be highly inflationary ...”
Look at the stark similarities to today’s environment.
There was fiscal stimulus at a time of full employment that triggered an overheated economy.
A near-zero real Fed funds rate at full employment also overstimulated the economy — again, this was only recognized by the time the inflation genie was out of the bottle.
We had a president who was protectionist, irritable, divisive, anti-media, ran what was considered at the time to be a risky brand of foreign policy, and still found time to badger the Fed. Sound familiar?
It was a very long cycle, too — now the third longest on record. At the time, as everyone was playing with Slinkies and hula hoops, the widespread belief was that a recession was a long ways away (Gary Shilling was fired from Merrill Lynch for daring to call for it just before the downturn occurred).
And how fitting that the Nifty 50 craze that drove the stock market to new dizzying heights is very much like the FAANG mania that has come to dominate the latest leg of this bull run.
What was it Mark Twain said again about rhyming ? David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave.