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Hope and Change: Will Trump’s Infrastructure Plan Help the Economy?

By: Dennis Fulmer, CFA
Saturday, December 31, 2016

President-elect Trump is reported to be creating a task force to implement his campaign promise to increase infrastructure spending. After reviewing his website, we like reading about a “deficit-neutral plan… that supports investments in transportation, clean water, a modern and reliable electricity grid, telecommunications, security infrastructure, and other pressing domestic infrastructure needs.” Since we are in the financial business, it is our job to worry about deficits. Our current government commitments to Medicare, Medicaid, and Social Security are clearly on an unsustainable path, so we hope they stick to the “deficit-neutral” part. Their plan is to use investment tax credits instead of direct government spending to stimulate private investment. Economist Peter Navarro estimates that $137 billion in tax credits would stimulate about $1 trillion of private spending (source: Washington Post, “Trump team plans for infrastructure ‘task force’ to advance top spending priority, December 20, 2016).

Private spending would probably happen faster and would likely be more productive than public spending. For example, they are widening a local road (Market Avenue) from two lanes to four lanes. This project was discussed for ten years before they found the money and now seems to be moving at a glacially slow pace. I am not dismissing the need for better roads, but none of these projects are “shovel ready.” Private spending decisions are generally made by people risking their own money, and those decisions are made more carefully than when people spend other people’s money.

Increasing the deficit is a bad idea. We already have too much debt, and debt inhibits growth. Think back to when you first bought a house and signed on a big mortgage. Your cash flow immediately sees a big portion committed to those payments for what seems like forever! Sure, you get to live in a nice place, which is important, but you now have less cash to spend on other things. The Federal Debt burden is not quite as limiting as your own budget is because the government can keep issuing more debt. What we don’t know is how long investors will want to keep buying more of that debt. We do know the Social Security Disability Insurance Fund was out of cash and needed a bailout in 2015. The overall Social Security Fund is projected to run dry around 2034. Time is catching up to us. Do you know of anyone who wants to pay increased taxes to keep it going? Sustainability is a popular word for environmentalists, but it has been political poison to propose a sustainable entitlement policy.

In summary, we invest in businesses, and Trump’s plans are generally pro-business. We like a lot of his cabinet picks, but we fear he will not heed their advice. We believe reducing regulations will encourage growth, and faster growth solves some of our problems. Adding a lot more debt might provide a temporary boost, but it will likely retard our growth in the long run like it has in Japan and Europe.

Trump’s Proposed Tax Cuts – Will They Stimulate Growth or Just Increase the Deficits?

Trump’s plan is to lower the personal income tax and condense the brackets to just three from seven. The top tax rate would come down from over 40% to 35%, and a married couple earning less than $50,000 would pay no Federal income taxes. The corporate tax would come down from 35% to 15%. This sounds drastic, but the average business only pays about 22% due to tax credits and faster depreciation benefits already included in the tax code. Total corporate tax revenues are a lot less than the income tax revenues, so those tax changes won’t impact the deficit very much, but they could make us much more competitive. Capital gains tax rates remain about the same. He would like to do away with the estate tax but would not allow a step up in the cost basis, so heirs would face capital gains taxes when assets are sold. Further, he would eliminate some loopholes that benefit the rich--the most significant one, in our opinion, being the carried interest rule that allows hedge fund managers to pay taxes at the lower capital gains tax rate.

We hesitate to guess what the final outcome on tax reform will be, but we do think this is the best chance for significant tax simplification in decades. We do believe the supply side argument that lower tax rates stimulate growth. This is because investment takes place at the margin--meaning the dollars you have left over after the basic living costs are what are available for investing. Lowering the tax rates increases the amount of those dollars. Our desire would be for a simpler tax code with lower tax brackets and fewer deductions. We would require all elected government officials to do their own tax return with only a calculator--no accountants and no computer software to help them! That would result in major simplification.

In summary, tax reform is positive, but Trump’s trade policies might offset some of the positives as higher tariffs would retard growth. Ellen Zentner, the Economist at Morgan Stanley, commented that the recent stock market rise reflects investor expectations of higher growth, but investors can be like a two-year-old who wants results now and could throw a tantrum if the results are not immediate.

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