The Administration Now Faces the Hurdles of Reality

There has rarely been a new presidential administration in the history of the United States that has tried to get so much done in its first ten days as the current one. Most elected presidents talk about the first 100 days, but Donald Trump seemed to be in an executive order sprint during his first 100 hours. When you are trying to get your cabinet approved, organize your White House staff and issue several important executive orders all at the same time, a few missteps are likely. He didn’t seem to reflect on the full implications of what he was doing or check with the appropriate agencies.

The American political system prides itself on its checks and balances and the new president experienced that immediately with the reaction to his travel ban. Putting his Chief Strategist Stephen Bannon on the National Security Council principals committee as a voting member also raised considerable controversy. There is now talk of a shake-up in the White House staff. Trump had three campaign chiefs during his march to the presidency, so he is no stranger to staff turnover. An example of the need to create better discipline and organization within the White House team was demonstrated by the resignation of National Security Adviser Michael Flynn over his reported conversations with the Russian Ambassador to the United States and his failure to disclose the contents of those talks accurately to Vice President Michael Pence. Because Trump acts spontaneously and unilaterally, others on the staff may have felt that they were operating within a culture of anarchy and could act independently. That is dangerous and must be stopped.

One of the forces that may result in calming down Donald Trump is the complexity of accomplishing anything in Washington. All important legislation has to be sold to Congress, even within your own party. Every executive order will have implications well beyond its original purpose and many require a rulemaking and a comment period. Many items on the domestic agenda have international ramifications and it is important to seek the advice of regional experts. Cultural differences within the United States and abroad often make it difficult to anticipate the reaction to various initiatives. With many smart people in Washington, acting deliberately and drawing on them as a resource is a good idea.

So far the stock market and the economy seem to be taking the turbulence in Washington in stride. Equities have risen about five percentage points since the beginning of the year as investors look forward to the implementation of Trump’s pro-growth agenda of tax cuts, dismantling regulation and infrastructure spending. They are less concerned with the immigration issue, repeal and replacement of the Affordable Care Act, and the written opinions of the Supreme Court nominee. On the face of it, the economic plan almost assures an increase in growth. Cutting taxes for individuals and corporations will encourage more spending at the retail level and more capital investment. Rolling back many of the regulations put in place during the last eight years in the post-recovery period will give American companies more flexibility and enable them to reduce the burden of compliance. The economic cost of compliance amounted to billions and was particularly high for some financial and energy corporations.

Spending public or private money on infrastructure where maintenance has been deferred for decades will create jobs, improve our quality of life and make the country more competitive. Along with lower taxes and deregulation, investors recognize these positives and have been willing to buy equities in anticipation of improved corporate profits and stronger growth. The assumption is the favorable effects will begin to show up in earnings this year but we may have to wait until 2018 to see the real benefit of the economic plan. While the U.S. equity market has been rising almost every day, at some point the good news will be fully discounted and the market will be vulnerable to a correction. Valuations are becoming extended.

One of the key tenets of Trump’s economic program is that it is supposed to be revenue neutral. That will be hard to achieve while making significant cuts to corporate and individual income taxes. Partly for that reason the tax cuts may be trimmed from the levels originally announced. Limiting deductions was expected to provide some additional revenue to offset the reduction in rates but a key element of that plan was the elimination of the deductibility of interest costs by corporations. As an offset to this aspect of the tax reform plan, corporations would be allowed to deduct the full cost of capital assets acquired in the year they were bought. The problem here might be that companies would buy real estate or other assets to reduce their tax bill, bidding up prices to unrealistic levels. The plan would also limit interest deductions by individuals, but this proposal has run into sharp resistance from the real estate industry.

Another initiative that gained considerable traction in the House is the border adjustment tax. This idea would mitigate the revenue loss from lower rates and seemed totally consistent with Trump’s objective of encouraging manufacturing within the United States and discouraging imports. Under the plan exporters would not pay an income tax on products shipped abroad and importers would not be allowed to deduct the cost of products manufactured abroad but sold in the United States. In the absence of a stronger dollar to offset the loss of the deduction, this would put all retailers at a disadvantage and Congressional representatives in every state regardless of party affiliation are under pressure on this issue from their constituents. The energy industry, which imports crude for its domestic refineries, is also opposed to the border tax. In addition, the World Trade Organization and the European Union have objected to the plan. China has also told the president that it views the border adjustment tax as a punitive measure likely to provoke retaliation. The trade issue is clearly important to the administration. Trump has spoken of modifying NAFTA and other multilateral agreements in addition to calling China a “currency manipulator.” While international commerce may not be a “level playing field” given the application of the VAT in many countries as well as other bilateral imbalances, Trump does not want to start a trade war because that would impair his growth objectives. Lately, he has softened his language on trade in conversations with Canadian, Chinese and Japanese leaders.