Tag Archives: Government policy

Can We Afford a Tax Cut?

 

Taxes Image

 

Our favorite economist, Brian Wesbury of First Trust says “yes.”:

Congress took a big step last week toward enacting some sort of tax cuts and tax reform.

That big step was the US Senate passing a budget resolution creating the room for ten years of tax cuts totaling $1.5 trillion with a simple majority vote. This procedure means there is no need to break a filibuster by getting to 60 votes.

So right about now is when self-styled “deficit hawks” will start to squawk. They will claim the federal government simply can’t afford to boost the federal debt, which already exceeds $20 trillion, with no end in sight.

Let’s put aside the issue that between 2009-12 many of these deficit hawks were supporting new spending, when annual federal deficits were $1 trillion plus. Let’s just take them at their word that they don’t think any policy that increases the deficit can be good for the economy.

One problem with their argument is that the $1.5 trillion is an increase in projected deficits over a span of ten years, not a definite increase in the debt. If tax reform focuses on cutting marginal tax rates, particularly on overtaxed corporate capital and personal incomes, and can thereby generate faster economic growth, the actual loss of revenue could be substantially less than $1.5 trillion or maybe nothing at all.

The estimate of a $1.5 trillion revenue loss is based on “static” scoring, which means the budget scorekeepers on Capitol Hill make the ridiculous assumption that changes in tax policy can’t affect the growth rate of the overall economy. Just a 1 percentage point increase in the average economic growth rate over the next ten years would reduce the deficit by $2.7 trillion, easily offsetting the supposed cost of the tax cut.

Another problem for the deficit hawks is that despite a record high federal debt, the servicing cost of the debt is still low relative to both the size of the economy and federal revenue.

Late last week, we got final numbers for Fiscal Year 2017 and net interest on the national debt was $263 billion – that’s just 1.4% of fiscal year GDP. To put that in perspective, that’s lower than it ever was from 1974 to 2002. The peak during that era was 3.2% of GDP in 1991. The lowest point since 1974 was 1.2% in 2015, not far from where we are today.

The same is true for interest relative to federal revenue, which was 7.9% in Fiscal Year 2017, lower than any year from 1974 to 2013. The high point during that era was 18.4% in 1991 and the recent low was 6.9% in 2015. Again, we’re still pretty close to the recent low.

Yes, interest rates should move up in the years to come, but it will take several years to rollover the debt at higher interest-rate levels. Even if interest rates went to 4% across the entire yield curve, the interest burden would remain below historical peak levels relative to GDP and tax revenue.

The US certainly has serious long-term fiscal challenges. The US government has over-promised future generations of retirees and should ratchet back these spending promises to encourage work, saving, and investment. Meanwhile, we need the US Treasury Department to issue longer-dated maturities like 50-year and 100-year debt to lock-in low interest rates for longer.

However, the absence of these changes should not be an obstacle to boosting economic growth by cutting tax rates and reforming the tax code. Plow Horse economic growth is certainly better than no growth at all, but turning the economy into a thoroughbred would make it easier to handle our long-term budget challenges, not harder.

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Our Government Needs to Start Doing its Job

It’s probably not news to anyone that our country faces some serious problems.  However, members of Congress don’t seem to care enough to do anything but grandstand and argue.  The U.S. government is running a $700 billion deficit this year, but the last time Congress sent a real budget to the President’s desk was 2002.  That was 15 years ago!  Since that time Federal spending has largely been on autopilot via a mechanism called a Continuing Resolution (“CR” in Washington-speak).

The role of Congress is to make laws and decide how tax revenues should be spent.  Instead, they act as if they think their role is pretending to act as detectives.  This is not a commentary solely on the current kerfluffle in Washington.  As we noted, Congress has been abdicating its responsibility for 15 years.  Our elected officials would rather posture in front of the cameras than actually do the jobs we sent them to Washington to do.

 Brian S. Wesbury, Chief Economist at First Trust, commented:

 

At eight years, the current economic recovery is the third longest on record. Personal income, consumer spending, household assets, and net worth, are all at record highs. Stock markets are at record highs. Corporate profits are within striking distance of their all-time highs. Federal tax receipts are at record highs.

So, how is it possible that the federal budget, along with some state and local budgets, still look like they’re in the middle of a nasty recession?

The answer: Government fiscal management is completely out of control. Politicians find time to fret about Amazon’s purchase of Whole Foods and won’t stop bashing banks, but they’ve lost their ability to deal with their own fiscal reality.

… Illinois and the City of Chicago are running chronic deficits, while New Jersey and New York are fiscal basket cases.
Businesses and entrepreneurs create new things and build wealth. Politicians redistribute that wealth. And while some of what government does can help the economy, like providing defense or supporting property rights, the U.S. government has expanded well beyond that point. Politicians have never been this reckless or fiscally irresponsible.

Whenever we say this, people ask; “what would you cut from the budget?” And then, if you are actually brave enough to answer, you get attacked for “not caring.”

This needs to stop. Illinois is in a death spiral. Tax rate increases will chase more productive people out of the state, while ratchetting spending higher. And just like Detroit and Puerto Rico, the state will go bankrupt.

The U.S. government is on this path, but, because it has the ability to fund itself with the best debt in the world, a true fiscal day of reckoning is still 15-20 years away.

Government spending needs to be peeled back everywhere. It’s no longer a case of picking and choosing. And until that happens, the fiscal irresponsibility of the government is the number one threat to not only America, but the world.

No matter what politicians tell us, any pain caused by private sector greed will pale in comparison to the mayhem that collapsing governments can create. Just look at Venezuela or Greece! It’s time to reset America’s fiscal reality. And if that means debt ceiling brinksmanship, shutting down the government, or moving to a simple majority on spending decisions, so be it. It’s time to get serious!

 

We agree.  We should all tell Congress that it’s time to get serious.

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The Plow Horse is Dead – Long Live the Race Horse

Race horse

We have referred to the economy over the last decade as the “Plow Horse Economy.”  There has been a huge increase in technology available to the economy over that period of time.  “Fracking” has unlocked huge oil and gas reserves in the energy sector.  The “Internet of Things” is tying our appliances together, automating our homes, even allowing us to control them with voice commands.  Self-driving cars are becoming a reality faster than I believed possible.  3D printing is revolutionizing production processes.  Yet despite this dazzling technological revolution, the economy is only managing 1.2% GDP growth.

Why?

Many analysts believe that if we compare the economy to a horse, we have a thoroughbred economy that’s plodding along like a Plow Horse.  The problem is that the rider is too heavy.    That rider is the government.  It’s holding growth down.  In the year 2000 government was 17.6% of Gross Domestic Product (GDP).  In 2016 it was 21.1% of GDP, an increase of 20%.  That’s a big move from the private sector to the public sector.

Keep in mind that government doesn’t manufacture anything.

On top of that, government today regulates virtually everything, generating a hidden cost to producers and consumers.  Some analysts think it’s a miracle that the economy actually grew despite increased borrowing, taxes and regulation.

The incoming Trump administration has a staunchly pro-business agenda.  The focus on jobs and economic growth is front and center.  A new executive order instructs federal agencies to halt the issuance of more regulations, and the new President has indicated a desire to reduce them by 75%.   Another executive order has frozen hiring of federal employees, opening the door to replacing government employees with technology, something that has happened in the private sector.  Yet other executive actions advance the approval of the Keystone XL and Dakota Access oil pipelines – using American steel – creating new high-paying construction jobs and indicating an interest in making America energy independent.  Reducing tax rates, especially the high corporate tax rate, is another Trump administration objective.  It’s the carrot to encourage companies to build here, even as he waves the stick of high tariffs for goods brought in from overseas.  It’s getting a respectful hearing from otherwise skeptical business leaders.

These actions are not going to be enough, but they are indications that the new administration is determined to streamline government and incentivize private industry to grow.  According to Brian Wesbury, Chief Economist of First Trust, the earning per share of the S&P 500 is estimated to be $130, an increase of 20% in 2017.  Growth in earnings of that magnitude can justify an increase in market valuations and add a few percentage points to the annual GDP.

To get back to our horse analogy, it looks as if the jockey riding the horse will be put on a diet.  If that happens the thoroughbred who was a “Plow Horse”  may become a “Race Horse.”

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Tectonic Shifts – Looking Ahead to 2017

The election has created tectonic shifts in government and promises to make bold changes in the economy.  We have been gathering consensus views from some leading financial analysts for 2017

  • Global interest rates are going up.
  • Global inflation is going up.
  • Global growth is going up.
  • Recession risk is going down.

A new consensus is also building.  The rise of nationalistic self-interest is upsetting the old order the world over.  For the past decade central bankers have been in control of economic policy throughout the world.  It has resulted in low or even negative interest rates in an effort to stimulate economic growth.  The result has been like pushing on a string.  Growth has been slow (the string as a whole hasn’t been moving) and the middle class in the developed world has seen their wages stagnate and their jobs disappear (the middle of the string) while those at the top (the far end of the string) have been virtually unaffected.  It’s part of the reason for the change in political leadership in the U.S. and the re-emergence of economic nationalism as evidenced by the Brexit vote in Britain.

As central bank leadership takes a back seat to aggressive fiscal policy, we can expect political leadership to focus on job growth and economic relief for the long-neglected middle class.  Domestically, here is what we expect to see:

Tax reform:  Trump’s campaign promised corporate tax reform.  To make American companies more competitive globally, he has proposed reducing corporate tax rates from 35% to 15%.  A special 10% rate is designed to repatriate corporate profits held offshore.

Individuals will be taxed at three rates depending on income: 12%, 25% and 33%.

Fiscal policy: The Trump administration wants to spend new money on infrastructure: transportation, clean water, the electric grid, telecommunications, security, and energy.

Health care: Trump wants to repeal and replace Obamacare.

Trade: The new administration has vowed to withdraw from TPP (Trans Pacific Partnership) and renegotiate NAFTA (North American Free Trade Agreement).  They also intend to challenge China regarding currency manipulation and unfair trade practices.

Immigration: President-elect Trump intends to establish new, tougher immigration controls to boost wages, build a wall along the U.S./Mexico border, deport criminal aliens and end sanctuary cities.

Economy: 25 million new jobs over the next decade is the goal of the incoming administration.  They aim to boost economic growth from 1.5% to 3.5% or 4.0% annually.

The Trump administration will focus on job creation, economic growth, infrastructure spending, reduced regulation, and energy independence while reducing governmental efforts to prevent climate change.  The people that Donald Trump has chosen for his cabinet are largely from the private sector; people that have backgrounds in running successful businesses and creating jobs.

These things are the primary reason that the stock market has reacted well to the election of Donald Trump.  Corporate earnings have been essentially flat for the past three years.  Professional investors see opportunities for renewed economic growth, which will increase corporate profits.  While we view this development with optimism, we always remain cautious.  We expect increased market volatility, especially if terrorist attacks continue throughout the globe.  We also expect interest rates to rise as the Federal Reserve brings rates to a more historically normal level.

We also see opportunities for the creation of new companies.  The number of publicly traded companies has dropped by nearly 50% since 2000.  At the same time, the number of companies that are held by private equity firms has grown explosively – by a factor of six!  This provides a great opportunity for privately held companies to go public and provide yet another opportunity for greater market growth.

As always, we remain cautious in keeping with our philosophy of preserving our clients’ capital.  Over the long term, we see the potential for a new American renaissance.

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Oh No They Didn’t!

The big financial news of the moment is that the Fed decided not to raise interest rates, though 13 of 17 Federal Reserve officials say that they see a rate hike by the end of the year.  In their statement, they cited “recent global economic and financial developments” as their reason not to raise rates today.  However, Chairwoman Janet Yellen cautioned that people should not “overplay the implications of these recent developments,” saying that they “have not fundamentally altered” the Fed’s outlook on the economy.  All of this leads us to believe that we are likely to see a similar media build-up around the Federal Open Market Committee’s (FOMC) December 15-16 meeting.  (There is another FOMC meeting scheduled for October 27-28, but at this point, there is no press briefing currently scheduled for that meeting.)

Whenever the Fed finally does raise rates, expect it to be a very SLOW process.  Ms. Yellen alluded to as much when she said, “the stance of monetary policy will likely remain highly accommodative for quite some time after the initial increase in the federal funds rate.”  Charles Schwab’s Liz Ann Sonders provided the following chart, which bodes well for the stock markets (unless we are all wrong and the Fed suddenly starts hiking rates quickly):

Interest Rates

As we wrote just the other day, we expect the Fed to increase rates and would have preferred to see them do it sooner rather than later.  The rate increase is widely expected to be in 0.25% increments, which should not have any significant effects on the economy.

Following the Fed’s stand-pat announcement, the stock market actually declined slightly (and futures are down as we write this morning), indicating that their position is being interpreted as an indication that the Fed does not have total confidence in the strength of the economy.

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Why is Berkshire Hathaway is not on the “Too Big To Fail” list?

It appears that the Bank of England sent a letter to the U. S. Treasury asking why Berkshire Hathaway is not on the list of “too big to fail” institutions.

If you are on the list it is deemed that you are a financial institutions “whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.”

MetLife, along with a number of other primary insurers, has sued the U.S. government about it’s designation as an SIFI (‘Systemically Important Financial Institution.”)  Being designated an SIFI brings along with it considerably more regulation.

New regulations under the Dodd-Frank legislation, mandate that financial institutions that fit SIFI qualifications, will have to meet higher capital standards and develop contingency plans for potential future failures.

But here’s something that most people are not aware of: insurance companies often take out insurance against catastrophic losses from other insurance companies.  The companies that insure the insurance companies are called “reinsurers.”  Berkshire Hathaway, run by Warren Buffett, is the largest of these reinsurers in the U.S. and the third largest in the world.

So who is more important to the financial stability of the financial system, retail insurance companies or the big global reinsurance companies that insure the insurers?  To me, the answer seems obvious.

To use your local bank as an example.  If it goes broke (and many have) it’s no big deal because your money is insured by the FDIC (Federal Deposit Insurance Corporation).  But if the FDIC went broke, that would be a BIG DEAL.  Then no one’s bank deposits would be safe.

Insurance is Berkshire’s most significant business – accounting for 27% of net earnings last year – and providing Warren Buffett with the capital to invest in stocks and acquisitions.  But Warren Buffett has friends in high places which may explain the reason he’s not on “the list.”

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Is a Government Shutdown a Good Thing?

In the middle of all the media and political hoopla about the government shutting down, people who keep their heads when others are losing theirs may ask the important question about a government shutdown: is it a good thing or a bad thing?  Government shutdowns have happened before.  In fact, most people many not be aware that from 1976 to 1996 there were 17 shutdowns totaling 110 days.  Remember the horrors that were predicted in the run-up to the “Sequester.”   With the exception of the news media, almost no-one noticed.  From First Trust, we get the following comments:

It looks like House and Senate won’t  come to a budget agreement by midnight and, as a result, the federal government is going to partially shut down starting Tuesday morning. Run for the hills?  Armageddon: right?  Nope!

As we said a few weeks ago, a shutdown is not as scary as it seems.  Money still flows into  the Treasury Department and money still flows  out, for Social Security  or to make interest payments on the debt, for example.

The military, border control, food inspections, air traffic, prisons, weather service, and post office, all keep going.  And, as long as the Treasury Department has room to continue its “extraordinary measures” or if the  debt limit goes up in the meantime, Treasury still pays the debt as it comes due, without missing a beat.

The downside is that if you need a passport or want to get into a national park, you are out of luck.  Non-essential services stop and non-essential federal workers get furloughed.

So what happened in those previous shutdowns?  The economy kept perking along.  Keep in mind, in our country a government shutdown does not shut down the economy.   Here is what followed the longest one:

That was the three-week shutdown from mid-December 1995 to early January 1996 under President Clinton.  Real GDP grew 2.3% in the year before the shutdown, a 2.9% annual rate in Q4-1995  and then at a 2.6% pace in Q1-1996,  despite  the shutdown and  the East Coast Blizzard, a multiple day massive snowstorm in January that was followed by large floods. The real result of the 1995-96 shutdown was that politicians could no longer hide the fact that government was overspending.  And when politicians can’t hide, when the public finally finds out the “Emperor Has No Clothes,” there is a political reaction.  In the late 1990s, that reaction slowed government spending relative to GDP dramatically and the US eventually moved into surplus.

Is that likely to happen today?  Well, we doubt that we’re headed for a budget surplus, but the predictions of doom are overstated.

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