U.S. President-elect Donald Trump has vowed to slash taxes and boost spending on infrastructure. With Republicans controlling the Congress and the White House, hopes are running high in the equity market for sweeping spending and tax legislation that could boost corporate earnings and the economy.
Yet enacting fundamental tax reform and increasing any spending will be challenging and expensive, actually and politically—despite the specter of one-party control and the leadership role Congress will likely play in driving legislation. As a result, there is considerable uncertainty around which combination of tax and spending measures Congress will pursue, coupled with the uncertainty around how President Trump will govern and how he will work with Congress. Will his plans for increased defense and infrastructure spending be watered down by conservatives or, conversely, lead to surging debt levels and higher interest rates that undermine growth?
Impact on GDP
Even if all of Trump’s fiscal proposals are implemented, there is uncertainty over their estimated growth impact. This boils down to the fiscal multiplier, or estimates of how much each dollar of fiscal expansion boosts gross domestic product (GDP) (see my Global Macro Outlook “Global fiscal policy: a material change in tone”). We estimate that Trump’s plans could lift U.S. growth by anywhere from 3% to an extreme of 23% over the next decade, as the chart below shows.
This is mostly driven by Trump’s plans to cut income taxes. Deregulation and/or the awakening of “animal spirits” in the form of a sustained upsurge in consumer and business confidence could give an additional boost. Conversely, a more restrictive trade regime could raise costs for goods, potentially decreasing consumer spending and diminishing growth.
An aggressive tax reform agenda
We see corporate tax reform as the most likely outcome during this Congress because there is bipartisan support for it. However, there looks to be a major stumbling block: How to pay for proposals such as lowering the 35% corporate rate? A proposed move toward a so-called destination-based tax system with border adjustments—which functions like a 20% tax on imports but exempts exports—is a potential revenue raiser but is very controversial and complicated.
Corporate tax reform could also be offset with measures such as eliminating the deductibility of paid interest. This would likely be a game changer for equity and credit markets, reducing the incentive for companies to issue debt and buy back shares. This change would likely be packaged with full and immediate expensing of capital expenditures, making it more attractive for corporations to invest in their business.
Ultimately, if some of the controversial measures that are possible offsets for corporate rate cuts are dropped, the scope of the reform package may need to be revisited. Republican leaders for now look determined to pursue an aggressive tax reform agenda and appear committed to the cause of fundamental reform.
The broad set of Trump’s fiscal measures and Republican legislative priorities should be supportive of a strong U.S. dollar, either by boosting growth and tighter monetary policy—or by contributing to an improved trade balance (through looser regulation in the energy sector and/or border adjustments). This has been the driver of dollar strength since the elections, and it remains to be seen how much of this is “buy the rumor, sell the fact.”
The bottom line: Trump’s fiscal plans and Republican-led legislation could deliver a boost to U.S. growth, but the magnitude and potential side effects are highly uncertain.