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posted on 21 December 2017

Why The Trump Tax Cuts Will Not Stimulate Growth

by Elliott Morss, Morss Global Finance

Trump:

"We're going to cut taxes for the middle class, make the tax code simpler and more fair for everyday Americans, and we are going to bring back the jobs and wealth that have left our country."


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We already know the tax code is not going to be simpler. More fair? It depends on your perspective. Will it bring jobs and wealth? No. And here is why.

  1. Traditionally, we have thought jobs and wealth depend on the nation's total aggregate demand: the greater demand there is for goods and services, the more jobs and wealth will be generated.
  2. To stimulate demand, the government can reduce interest rates, spend more, or reduce taxes on individuals and business in hopes they will spend some of the tax savings. Trump et al expect individuals and business will spend at least some of their $1.5 trillion resulting from tax cuts.
  3. Research shows that these government stimuli work. The findings are that at times of high unemployment, increased government spending and cutting taxes will generate jobs and income.

So what is wrong now? We are at full employment - 4.1%. So what happens when you increase aggregate demand when you are at full employment? The usual result is inflation and/or the trade balance worsens as imports increase to meet the demand growth. And regarding inflation, The Fed is already increasing interest rates to ward it off.

How can we be at full employment with slumping wages? Slumping wages are the result of a diminishing demand for workers. And unlike what Trump claims, most jobs were not lost to less expensive overseas workers, they were lost to labor saving automation.

So in these circumstances, how will the tax cuts be used? There are a number of possibilities:

  • Wealthy individuals might not spend them at all.
  • Poor individuals will probably spend most of any tax savings they receive. However, it is not yet clear how the tax reforms will affect these individuals.
  • Corporations have a number of options. They could pay them out as dividends to their stockholders or they could simply increase their cash balances. The most likely outcome is that they will use them to buy more labor-saving technologies, thereby reducing unemployment and lowering wages.

What evidence is there to support the claim that corporations will use the tax cuts to replace workers? The evidence is what has been happening for more than a decade: job losses to automation in both the goods and services industries that have been happening for the last two decades.

That in a nutshell is why the tax cuts will not do what Trump wants them to do.

Investment Implications

Investors will soon learn that the Trump tax cuts will not bring back "jobs and wealth." And when they do, there will be a significant sell-off. This is a time to invest in high dividend stocks with low payout ratios.

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