The Macro Report | July 2017

Reflation expectations lose lift


The ambitious policy agenda of the Republicans appears to be narrowing to two issues of importance to investors: the debt ceiling and tax reform.

It has been six months since the start of the new administration, and it’s worth bearing in mind how delayed the Trump agenda is. With the U.S. Senate consumed by the health-care debate, attention in the House of Representatives has shifted to budget issues. There are several components: raising the debt ceiling; a budget resolution for the next fiscal year; and the debate about tax reform. These issues are closely related, and tax reform is directly connected to the health-care debate because of the role of the Affordable Care Act taxes. Also, the Republicans are working to pass reforms under the Senate’s “reconciliation” rules, which require only 51 votes to pass a measure rather than 60, and would avoid the challenge of attracting support from Senate Democrats.

Avoiding debt drama
Two matters seem most important in these issues. The first is the debt ceiling, and how much drama there will be around raising it. The latest Congressional Budget Office estimates put the deadline in early October. All the key players have taken default off the table, and it seems reasonable to take them at their word. The second matter is whether there will be any growth-enhancing tax reform, and whether that growth enhancement comes from a genuine redesign of the tax code that improves economic efficiency, or whether it takes the form of tax cuts and their impact on corporate and household spending.

The U.S. tax code is clearly inefficient, and there’s no lack of good reform proposals that have been floated by various think tanks in Washington. The benefits of reform seem large and obvious, but the problem is that the beneficiaries of the current distortions in the tax code are very effective at lobbying for protection and many of them have very deep roots in the political system. Even the current administration, which campaigned to “drain the swamp,” has promised to maintain some of the largest distortions. Because the revenue costs of protecting these special deals are so large, they are difficult to overcome.

There are now indications that any tax measures adopted will be revenue neutral, and arguably will have no growth impact worth talking about. Washington has achieved precious little of economic significance in half a year under the new administration, and the latest noises suggest we need to lower our expectations for reform still further.


More from Macro Report
Download the Macro Report (PDF)