Boom or Bubble With Trump

This article from the August 2019 IPA Review is by IPA Research Fellow, Kurt Wallace

On 27 December 2016, just under a month before his inauguration, Donald Trump tweeted: “The world was gloomy before I won—there was no hope. Now the market is up nearly 10 per cent and Christmas spending is over a trillion dollars!”

Before even entering the Oval Office, Trump took ownership of an economy he described just three months prior as “a big fat ugly bubble”. In debate with Hillary Clinton, Trump criticised the economic recovery from the Global Financial Crisis under Obama as “the worst revival of an economy since the Great Depression”. He went on to criticise the Federal Reserve for playing politics with monetary policy:

We have a Fed that’s doing political things… by keeping the interest rates at this level. And believe me: The day Obama goes off, and he leaves, and goes out to the golf course for the rest of his life to play golf, when they raise interest rates, you’re going to see some very bad things happen, because the Fed is not doing their job. The Fed is being more political than Secretary Clinton.

Of course, the idea that the current president bears full responsibility for the economy ignores the impact of business cycles, monetary policy, state and local governments, and external market forces. That said, it is clear the stock market did boom in response to Trump’s election, and under Trump’s presidency the official unemployment rate is now at a historically low level, and consumer and business confidence is strong.

Two recent books from free-market economists who were involved with the Reagan administration present very different pictures of the ‘Trump economy’ and the impact of his economic policies. The Republican insiders, Art Laffer and Stephen Moore, sing the praises of Trump’s tax cuts, deregulation, and energy policies in their book Trumponomics: Inside the America First Plan to Revive Our Economy, while bearish investor and economist David Stockman in his book Peak Trump: The Undrainable Swamp and the Fantasy of MAGA, argues Trump was right the first time when he referred to the economy as “a big fat ugly bubble” and doesn’t believe Trump has been successful in draining the swamp and making America great again.

The supply-side economics advocated by Laffer and Moore—closely associated with the policies of Ronald Reagan—have long been idolised by the Republican establishment. Before Trump’s election, few Republican insiders believed Trump would in any way embody the economic ideals of Reagan, centred on the idea of the power of tax cuts to generate economic growth.

Trumponomics tells the story of how Trump brought Laffer, and Moore (along with Larry Kudlow, who Trump would later appoint Director of the National Economic Council) into his team to design a tax plan that would deliver widespread tax cuts to generate economic growth. The book gives an inside look into how Trump’s economic policies were designed and implemented.

Cutting taxes generates economic growth that reverses the negative revenue effect of lowering taxes

Trump won the presidency distinguishing himself from the wide Republican field with strong rhetoric against US trade partners, advocating tariffs to protect American industry, and a hard-line approach to immigration—hardly a platform attractive to free-market economists. In fact, Laffer and Moore had gone on record against Trump’s protectionism before being approached to advise Trump on tax and energy policy.

Laffer and Moore praise ‘Trumponomics’ as an incarnation of supply-side economics. They emphasise cutting red tape, slashing taxes and spending, and taking advantage of natural resources, while downplaying concerns on trade and immigration. Trump’s protectionism is cast as a concern for fairer trade deals, and the threat of tariffs as a way to negotiate for opening up trade. Merit-based immigration is defended, with reservations expressed about Trump’s desire to reduce overall immigration. Overall, Laffer and Moore believe the positives outweigh the negatives.

In 1974 Art Laffer explained his theory to Republican office-holders Dick Cheney and Donald Rumsfeld, on a napkin, over a famous lunch, recreated here 40 years later.

In 1974 Art Laffer explained his theory to Republican office-holders Dick Cheney and Donald Rumsfeld, on a napkin, over a famous lunch, recreated here 40 years later. Photo: YouTube/Bloomberg, https://youtu.be/4yBgTN5JT-Y

Trump is presented as a bold, results- oriented president. When presented with a tax and energy policy promising 3 to 4 per cent growth, Trump’s response was, “I want 5 per cent growth.” According to Laffer and Moore, Trump is deeply motivated by a desire to help the millions of Americans who have suffered from a sluggish economy and have not been included in the Obama recovery. To achieve this, Trump fully embraces the logic of Laffer’s approach to tax cuts and growth: cutting taxes generates economic growth that will substantially reverse the negative revenue effect of lowering taxes.

In addition to income tax rate cuts across the board, Trump delivered a massive cut to the corporate tax rate from 35 per cent to 21 per cent. Laffer and Moore make the economic growth argument for the reduction based on increased capital investment, which increases productivity and drives up wages and benefits.

Prior to the cut, Laffer and Moore argue the US top corporate tax rate was at an extremely uncompetitive rate, functioning as “nothing more than a 20 per cent ‘Head Start program’ for every country that America competes against”.

When Trump spoke with a group of 25 CEOs, Laffer and Moore expected tax cuts to be front-and-centre of their concerns. The mood was summed up by an executive who said, “We are being strangled by regulation and red tape. If you want to make America great again, please put a muzzle on the regulators”. Laffer and Moore say this was the catalyst for Trump’s one-in-two-out approach to regulation, which has led to closer to 22 regulations repealed for each new regulation.

Trump’s energy policies were also centred on delivering growth and high-paying jobs. By rejecting the Paris climate agreement as a “hoax on American workers” while embracing natural gas and clean coal, Trump was able to drive the US towards energy independence.

The famed Laffer Curve Napkin.Photo: National Museum of American History

The famed Laffer Curve Napkin. Photo: National Museum of American History

While the differences between Donald Trump and Ronald Reagan are noted—Reagan as deeply committed to the ideals of free market economics and freedom, and Trump as a pragmatic, results-oriented, pro-business president—Laffer and Moore identify Trump as the first President since Reagan to continue to build on his economic vision.

Trump has repeatedly quoted the high S&P 500, strong jobs growth numbers, and low unemployment as proof of his success at making America great again, but questions remain about the long-term sustainability of the economic boom. While not detracting from the merits of cutting taxes and regulation, the case can be made that Trump has just added more air to the bubble.

This view is taken in Peak Trump by David Stockman, who has long opposed the supply- side economics of Laffer and Moore, and strongly rejects their high view of Trump. The disagreement is most readily seen in the debate over tax cuts, deficits, and debt.

Bush and Obama’s massive expansion of debt left the country with nothing to show for it

Stockman argues that “tax cuts are just plain not efficacious if they are deficit-financed and the resulting public debt is not monetised by the Fed”. Without spending cuts or the Fed stepping in to buy the debt, the crowding- out effect of government borrowing decreases capital investment and weakens the economy. When governments deliver tax cuts by increasing borrowing, they force interest rates up and drive money away from private investment.

Laffer and Moore respond to the question of debt by saying, “We are not opposed to debt per se… If the debt is used to finance growth, then it can make sense and the borrowing can benefit future generations”. Not all debt is the same. Reagan’s debt helped fund the Cold War and delivered economic growth that “helped rebuild the US economy after the dreadful stagflationary 1970s”. Bush and Obama’s massive expansion of debt, on the other hand, left the country with nothing to show for it.

“If you want to make America great again, please put a muzzle on the regulators”

But Stockman sees the growing debt as a time bomb that could blow up on Trump’s presidency. He argues there is no stopping the “Fiscal Doomsday Machine” because Trump has retired the Republican Party from “the job of fighting for fiscal rectitude”. Should interest rates return to just 4 per cent, the increase in interest expenses on private and government debt would swamp the size of the tax cuts.

The Republicans have not mounted opposition to growing welfare spending and Trump’s anti-foreign intervention rhetoric has not transformed into reductions in military spending. While Stockman is at times distractingly hostile toward Trump, he lays blame for the military spending on the “Russiaphobia” of the Democrats and mainstream media “virtually begging for military confrontation with Russia”.

Stockman views the wave of Baby Boomers entering retirement as a major problem for welfare spending commitments. Without significant welfare reform, he argues the only solution is increasing the intake of migrants who will work, pay taxes and not burden the welfare system. This comes at a time when Trump is talking about tightening up on immigration. Stockman challenges the efficacy of the corporate tax rate cuts. In practice, most corporates were never paying anywhere near the 35 per cent rate. Sophisticated tax planning and shelter schemes ensured the effective rate was much more competitive internationally. Stockman argues the corporate tax rate should be completely abolished, but only through a reduction in spending or a reform of the tax system.

If the US enters a recession, government receipts will dry up, blowing out the deficit and debt and increasing interest payments. Stockman attacks the rosy assumptions in the budget forecast for assuming away the possibility of recession when the current economic expansion is nearing record lengths.

But Trump has taken ownership of the US economy by measuring the success of his economic policies by favourable economic numbers. No longer is the economy in a “big fat ugly bubble” and no longer are the official unemployment numbers a “complete fraud”. Contrary to Laffer and Moore, who praise the Trump boom, Stockman considers there to be a high degree of hubris on the part of the president:

… the Donald heedlessly and incessantly embraced the transient 3.7 per cent unemployment rate as if it were all his doing—when it was actually a clanging warning bell to pull out the stops blaming the swamp creatures of the Imperial City for a Fake Boom that couldn’t last.

Laffer, Moore, and Stockman agree on tax cuts, cutting red tape, and opening the energy market. They share concerns about restricting free trade and immigration. They disagree on the stability of the bipartisan approach to debt and monetary policy. If Laffer and Moore are correct, the boom will continue by cutting taxes, slashing regulation, and pro- American energy policies, and Trump will return in 2020. If Stockman is correct, Trump better hope the longest economic expansion in history continues into uncharted waters.

David Stockman was the “Father of Reaganomics” but quit as budget director in 1985, criticising the failure to reduce government spending to offset tax cuts. Photo: Official White House photo by Shealah Craighead