Donald ducks the big questions
Donald Trump’s proposals require implausible spending cuts or 10% growth
VICTORY this week in the Nevada caucuses, on top of recent triumphs in New Hampshire and South Carolina, make Donald Trump the clear favourite to be the Republican nominee in America’s presidential election. Users of Predictit, a gambling website, collectively rate his chances at about 70%. Although many people think that Mr Trump cannot triumph in November, it is worth remembering that Hillary Clinton, the likely Democratic nominee, is hampered by several nagging scandals that could conceivably deepen.
So investors need to start thinking about what the economy might look like under a President Trump. This is far from easy, because the candidate gives a good impression of making up policy as he goes along. How seriously is one to take his policy on Chinese trade (declaring the country a currency manipulator and eliminating its “illegal” export subsidies)? Is the plan for a border wall contingent on his improbable promise of getting the Mexicans to pay for it?
And it is not clear whether Mr Trump’s policies would be approved by Congress. A Republican House and Senate would normally follow the lead of their party’s standard-bearer. But Mr Trump has departed a long way from party orthodoxy in some respects, such as declaring the Iraq war a “terrible mistake”.
On taxes, at least, Mr Trump is not so different from other Republicans, arguing for sweeping cuts. He wants a higher standard income-tax deduction, along with lower bands of 10%, 20% and 25%.
Dividends and capital gains would be taxed at 20% at most. The alternative minimum, estate and gift taxes would all be abolished. The corporate-tax rate would be cut from 35% to 15%.
The cost of these cuts would be partly offset by limits on certain deductions, and by taxing companies’ global profits, whether repatriated or not.
Part of Mr Trump’s “man of the people” appeal is his apparent divergence from Republicans on some tax breaks for the rich. One example is his promise to end the tax break on “carried interest”, which allows private-equity fund managers to cut their bills substantially. But the Tax Policy Centre (TPC), a think-tank that has analysed Mr Trump’s proposals, points out that although his plan does indeed reclassify carried interest, it would still cause the effective tax rate on it to fall from 23.8% to 15%. The billionaire need not worry about losing the private-equity vote.
How will all this be paid for? Lower taxes could stimulate economic growth, although the size of the improvement is debatable and it could be offset by higher debt-servicing costs. The TPC estimates the tax cuts would reduce revenues by $9.5 trillion over ten years. The Committee for a Responsible Federal Budget (CRFB), a fiscal watchdog, puts the total cost at $12 trillion-15 trillion. Debt could rise as high as 140% of GDP by 2026.
Perhaps Mr Trump is a secret admirer of Paul Krugman, a liberal economist, and plans a big Keynesian stimulus? Not so: he has called for a balanced budget. That would mean huge spending cuts, but he has not outlined many. He wants to beef up the armed forces, and to spend more on veterans and immigration controls. He has also promised to protect Social Security (the national pension scheme).
Mr Trump says he will save $300 billion from Medicare (the government health-care scheme for the elderly) by buying drugs more cheaply. Alas, total Medicare spending on drugs is likely to average $111 billion annually over the next decade. Aggregate American spending on drugs (public and private) is around $300 billion a year, says the CRFB. Perhaps Mr Trump thinks he can persuade the pharmaceutical companies to give their product away: the “art of the deal” in action.
As the chart shows, the more departments that are protected, the bigger the cuts needed elsewhere. Funding his tax cuts would require spending reductions of 61-78% in the unprotected areas; balancing the budget would be impossible, according to the CRFB, as there is not enough spending left to cut. For those counting on economic growth to eliminate the deficit, the annual increase in GDP required would be more than 10%.
All politicians promise too much, of course, but Mr Trump’s plans differ in the sheer scale of their implausibility. If investors also factor in the candidate’s unpredictability, the wildness of his foreign-policy rhetoric and a potentially fractious relationship with Congress, it all adds up to considerable uncertainty, something that markets traditionally dislike. If Mr Trump does become the Republican nominee, prepare for a volatile autumn.