- Donald Trump’s policy agenda shows a clear shift of focus towards the domestic economy
- The emphasis until now has been on those issues that can be addressed through executive orders, including immigration, de-regulation and trade
- Initiatives for more fiscal spending are increasing, while there is still little clarity on revenue generating actions
- We continue to think the positive momentum of the US economy will get an impulse from President Trump’s economic agenda
- However, there are downside risks related to the size and timing of the fiscal stimulus
- The tactics being discussed to promote foreign trade remain a risk as well
The main issues in his address to Congress
On Tuesday, President Donald Trump addressed a joint session of the Congress for the first time, laying out his “America First” agenda, which focuses on controlling immigration, reforming the tax system, health care and trade agreements, as well as reducing regulations and improving infrastructure. In his first 40 days in office he has already issued more than 20 executive orders and given numerous press conferences to discuss how he will deliver on some of these proposals. These announcements have been embraced by consumers, firms and investors. In this note, we assess the progress made in Mr Trump’s main campaign proposals compared to the base scenario we sketched in November 2016.
Fulfilling his campaign promises
President Trump’s has been actively delivering on several of his campaign promises to pursue “buy American and hire American”. The agenda broadly coincides with what Americans consider as major priorities (please see table), but President Trump has given more emphasis until now to those issues that can be addressed through executive orders, including immigration and de-regulation. Indeed, the first steps have been made to support the building of a wall at the Mexican border, while de-regulation has already started, concretely in the manufacturing and energy sectors. However, tax reforms are still in the making. The major issue is finding the offsetting revenues. We expect the budget process will offer more clarity on this proposal. Other policies, including health care reforms and infrastructure spending, are facing practical constraints. This has to do with the ongoing confirmation of his cabinet and the appointments within his Administration, as well as the complexity of the process. Meanwhile, the withdrawal from the Trans-Pacific Trade Partnership was tackled with diligence through an executive order.
Our base scenario assumes a somewhat more nuanced approach to protectionism than announced by President Trump so far. This seems to be on track. Since there are have been no signs of outright protectionism. However, the tone regarding the future of trade remains aggressive. Our base scenario included the withdrawal from the Trans-Pacific Partnership Trade Pact and a review of the North American Trade Agreement (NAFTA). The former has already happened and in compensation the Administration has said they would pursue bilateral free trade opportunities to promote industry and the American worker and that wages would be raised instead. At the same time, President Trump remains committed to renegotiating NAFTA to achieve more favourable conditions. We think that there is still a small probability of withdrawal if the negotiations are unsuccessful for the US.
During his address to Congress on Tuesday, he mentioned that he favoured free trade, but also fair trade. Since his election, President Trump has mainly threatened to put higher tariffs on firms intending to move their production to Mexico. We think that proposals to increase tariffs on China (45%) and Mexico (35%) and declaring China a currency manipulator will not see the light of day. These type of proposals are contrary to free trade agreements and would lead to disputes with WTO members. Moreover, any intentions to take unilateral action to level trade sanctions and bypass the WTO, as has been discussed by a few of his advisers, would likely encourage retaliation from other countries. We see some tension developing ahead with the WTO given the remarks made by the current Administration with respect to the sovereignty of the US with respect to this organisation.
As for his cabinet appointments and his inner circle of advisers, several are supporters of free trade, including Steven Mnuchin, Rex Tillerson and Terry Branstad (Ambassador to China). This will offer a more balanced view to policymaking given that there are a few nominations that favour a protectionist stance, including Robert Lighthizer, his pick for US Trade Representative, and Peter Navarro, the head of the National Trade Council. In the past, both have suggested that the US take a more protectionist stance. This balance is important given that the President has the power to withdraw from trade deals through executive orders.
Our base scenario includes corporate tax cuts from 35% to 20% and measures that would partly offset the decline in revenues resulting from the tax cut. Referring to tax reform, Mr Trump mentioned in his address to Congress that he wants a level playing field for American companies and workers, referring to the high corporate tax rates. The speech did not mention where additional revenues would come from to support his proposals. Stronger economic growth remains the main source of additional revenues.
On top of this, the discussion on the border tax adjustment as presented in the tax plan of the House of Representatives (GOP plan) “A Better Way” is still alive. This proposal would tax imports at the corporate tax rate and exempt income earned from exports. With this proposal the intention is that tax cuts are implemented in a revenue neutral manner. In this sense, the GOP Border Tax Adjustment proposal would raise USD 1.2 trillion over the next ten years. This would cover part of the decline in revenues resulting from the reduction in the corporate tax rate, which would indeed, as we assumed, fall from 35% to 20%. The more difficult it is to adopt offsetting measures, the harder it will be to propose a large reduction in tax cuts, unless there is a decision to abandon the goal of revenue neutrality. We have in fact, included an increase in the fiscal deficit in our scenario.
As for the income tax, Mr Mnuchin the Treasury Secretary, has said that the tax reform would not favour the upper class as some of the estimates suggest, given that some deductions would be eliminated. Instead the reforms would focus on a “middle income tax cut”.
Our base scenario considers stricter migration policies, mainly directed at deporting illegal immigrants. Actions surrounding immigration started with the plan of building a wall at the border with Mexico and enacting a ban on immigrants from seven Muslim countries that pose a particular risk of being terrorists. These policies have been more ambitious than we expected and the outcome has led to a lot of uncertainty regarding future immigration. During his address he emphasised a merit-based system for immigration, the construction of a wall at the southern border, while enforcing the rule of law at the borders, but did not mention the immigration ban. There has been some division within the Republican party regarding this action. The immigration ban has had a high political cost for President Trump’s both domestically and internationally. We think that the initiatives to restrict immigration more widely would reduce labour supply after a while and tighten the labour market, while policies to restrict illegal migration would have a limited effect.
Our base scenario assumed a reduction in financial sector regulations, in particular a review of the Dodd-Frank Act, but President Trump has gone much further. Limiting regulation has taken different forms. To begin with, he signed an executive order indicating that agencies that adopt a new regulation will have to eliminate at least two existing regulations. At the same time, an effort will be made to offset costs associated with new regulations by reducing existing costs associated with current regulations.
The most recent move is an executive order requiring every agency to establish a task force focused on eliminating unnecessary regulations. Agencies will present regular reports on the progress made. Concretely, while this process is put in place, an executive order has been signed to minimise the burden of the Affordable Care Act and procedures for mining, energy and manufacturing companies. However, efforts to relieve legislation in the financial sector have been delayed. In fact, he did not mention the Dodd-Frank Act in his speech to Congress. We think that it is only a question of time before regulatory relief comes for the financial sector. It is likely that Dodd-Frank reforms will be implemented next year.
We have included infrastructure investment in our base scenario amounting to 0.25% of GDP annually over 10 years, starting this year. Compared to other topics, infrastructure has received much less attention since President Trump took office. Initially upgrading public infrastructure was a campaign promise for which USD 1 trillion would be allocated. In his address to Congress, he mentioned that the time has come for a new programme of national rebuilding. He mentioned he would ask Congress to “allow USD 1 trillion in investment for infrastructure”. Proposals that have circulated to improve infrastructure, include a tax credit to encourage private investment. We think that despite the tax credits, it will be difficult to raise enough interest from the private sector to get a quick start this year. As a result we see downside risks to our assumption of additional infrastructure spending this year. It seems more likely that this will occur in 2018. This despite the announcements that have been made recurrently by Trump on “big spending” in infrastructure.
We think that the positive economic momentum will get additional support from President Trump’s agenda in the coming months. Fiscal stimulus is still in line with his campaign promises, but there are risks related to the size and timing of these measures. The main problem is related to the offsetting policies to reduce the impact of tax cuts and additional spending. There is a some of room for a higher fiscal deficit, without putting at risk the support of his Party. However, at this point it appears that choices will have to be made and it looks like infrastructure spending could be delayed for now, while the corporate tax rate of 25% is now in discussion, particularly for small businesses who have been taxed on their income and who constitute a big chunk of tax revenues. There are some signals that the tax cut could be slightly less ambitious than the 25% proposed by the Republicans.