2017/01/05 Commentary: The Word is ‘Retroactive’
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COMMENTARY: Thursday, January 5, 2017
The Word is ‘Retroactive’
The impressive post-election Trump-o-phoria US equities rally has stalled since mid-December. Maybe that was to be expected from an S&P 500 Index that had run up $250 from the panic election night overnight electronic low. Even the strongest of markets tend to get tired after extended divergence above the longer term underlying trend momentum. And this was no different for one very good additional reason: all the inferences of more amenable economic and business policies were derived from Trump’s broad pronouncements during the election campaign. Even though they were very cursory, that is just the sort of future policy indication which tends to encourage best case anticipation for such a major policy shift. On the other hand, they eventually come under review.
As the Trump cabinet selections begin their confirmation process next week, this is also just the sort of phase where markets tend to question what is actually going to transpire. An additional fly in the upbeat economic outlook ointment is the degree to which the Trump nominees will rightfully commence with the roles relating to legal and security matters prior to moving onto the more economic and market oriented positions. And even once the economic and business factors become a major focus of the new administration after the inauguration, there is the issue of just what the Congress will approve and how much of it is consistent with the campaign pronouncements and more recent assertions of President-Elect Trump. There are some deficit hawks in Congress and other actors with still very wide-ranging opinions of how to implement the economic program.
And there is one factor which has historically been a real challenge for the economy and markets in any productive supply-side changes to the US business environment. That is the degree to which any of the inducements for investment and hiring may not apply to the current calendar year. We suppose the Republicans and Mr. Trump have gone to school on the problems that plagued the Reagan Revolution 35 years ago.
While all of those plans turned out to be very productive in the long run, that era’s deficit hawks demanded a ‘phase-in’ through 1981 and 1982. This either caused or at the very least contributed to the 1981-82 recession prior to the boom. The issue facing the Trump team and Congress now is whether they can pass enough positive measures that can reasonably be made ‘retroactive’ into the current (2017) tax and fiscal year. If they can, then there is some potential for the economic impact to be immediate. If not…
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NOTE: Given the likelihood the US economy will now get the structural reform that we (along with Mario Draghi and others) have been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015, we need to adjust our view that a potential economic and equity market failure is coming. We previously referred you back to our December 8, 2015 post for our major Extended Perspective Commentary. That reviewed a broad array of factors to consider Will 2016 be 2007 Redux? While a continued regime of higher taxes and more regulation (i.e. under Clinton) might have fomented a continued weak or even weaker US economy, the tax and regulation changes proposed by a Trump administration that will likely be approved by the heavily Republican Congress now diminish the similar fears we had to what transpired in 2007-2008.
▪ …well, if not then the entire exercise bogs down into a weaker than expected 2017 compared to the euphoria which took hold in the immediate wake of Trump’s election. Aside from any of the other potential drags from trade issues surrounding Trump’s more aggressive stances in that area, there is a simple calculus at work. If the best benefits from the Trump-inspired structural reforms are not available to companies in 2017, they will not make the investments until 2018. Why would a corporate CEO, CFO or board of directors possibly invest in plant and equipment or additional staff this year if the benefit is so much greater after January 1, 2018?
This is exactly what happened to the Reagan reforms, which also caused many folks to question whether the Reagan program was going to work at all by 1982… even though the real impact of the reforms was not even going to hit until 1983 and beyond. Of course, the naysayers were proven seriously wrong from 1983 onward. That is likely to be the case for the Trump-inspired reforms that will undoubtedly see some meaningful evolution on their way through Congress.
Yet as opposed to the supply-side reforms of the Reagan era that were disparaged as “voodoo economics”, the acceptance of lower taxation and regulation as a fillip for the economy was established back then as the right way to develop and extend economic growth. It had been used previous by other US Presidents going back to Kennedy and Roosevelt, yet never before in the face of such extensive opposition to the ‘received wisdom’ as after Ronald Reagan defeated the very ‘progressive’ Jimmy Carter.
▪ And the lesson for the markets? It is that there is no lesson yet, pending what we find out about whether the US Congress has the gumption to make productive tax and regulatory changes retroactive. That is easier with the latter, as so much accelerated implementation of the regulatory agencies’ policies that has depressed business investment can be wiped away with the stroke of a Presidential pen. That is due to Barack Obama having approved so much of that accelerated regulation by executive order, which means quite a bit can be reversed merely by a countervailing Donald Trump order cancelling it.
Tax policy is more complex, as it requires legislation to be passed through Congress. As such, that may take months to accomplish even as the Republican Party coalesces around a specific plan. If that is only due to begin at the top of 2018, there will not be much impact on the US economy this year. And that may leave equities in a less upbeat mood for at least a while in spite of the surety of more aggressive investment and hiring in 2018.
However, if Congress takes the initiative on retroactively applying some significant portion of the reforms to 2017, both the US economy and the markets will have reason to strengthen further this year. Can Congress actually look past any short-term ballooning of the fiscal deficit that would likely accompany accelerated tax reform? We shall see.
Yet as far as the legal basis for applying retroactive policies, if they can marshal the votes they can do whatever they want. The best historic example was the major Tax Reform Act of 1986, which applied immediately in that year even though it was not passed into law until October 22, 1986. That was much to the chagrin of many real estate investors who saw the tax shelter provisions of the investments they held eliminated after the tax year was already almost over, and for all future years on those investments.
A couple of years later Congress was investigating who was responsible for the Savings and Loan Crisis. That was based on the sinking property values which hit the S&L’s loan portfolios, but nobody had the gumption to tell Congress it was basically their fault outside of a very limited number of cases of outright fraud. While the elimination of the tax shelters was a positive overall development for the US economy, this is a cautionary tale on exercising due caution when making major tax policy and regulatory changes.
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