What does the surprise election of Donald Trump herald for the U.S. economy? Will he, as he often claimed in the campaign, make America great again? And what does that even mean? Moreover, what are the implications of Trumponomics for the rest of the world?
These are not easy questions to answer, in part because Trump often was not very specific in his campaign. And even when he did promote certain policies, it is unclear whether he was serious.
Trump and the economy
Before we measure the potential impact of Trumponomics, it helps to have an accurate benchmark. According to the Canada-based Fraser Institute, which publishes Economic Freedom of the World, a nation’s economic performance is largely a function of the quality of its government and the degree to which economic policy is friendly or hostile to the private economy. The Fraser Institute uses five measures when ranking countries. Let’s look at those factors and speculate on whether Trump will move policy in the right direction or wrong direction.
Rule of law and security of property rights – America’s score has been declining in recent years because the Obama Administration arbitrarily used government power in ways that were not consistent with the law. It is difficult to know whether Trump will return to a more rules-based system, but his successful bullying of Carrier suggests that he also will use government power in a capricious manner.
Fiscal policy – Trump has proposed a big tax cut and most of the provisions would reduce penalties on work, saving, investment and entrepreneurship. Though it is unclear whether to take this plan seriously since he does not have a concomitant plan to rein in the federal budget. Indeed, he even made comments suggesting he would not touch entitlement programs, a very worrisome sign.
Trade policy – If rhetoric is any indication, Trump’s protectionism could pose a significant risk to global trade. What’s not clear at this point is whether he simply wants to preclude new initiatives like the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, or whether he genuinely wants to roll back existing pacts such as the North America Free Trade Agreement.
Regulatory policy – The president has expressed unhappiness with the amount of regulation emanating from Washington. And there is good reason to be concerned since the regulatory burden has reached record levels under Obama. Without knowing what legislation he will support and without knowing most of his regulatory appointees, it is hard to judge whether he intends to liberalize markets.
Monetary policy – This is a black box. Trump has said very little about monetary policy, so the most that can be said is that he might have a bias – based on his background in commercial real estate – for artificially low interest rates.
Donald Trump, is a policy mystery, but he presumably will have some power to drag congressional Republicans along whatever path he ultimately chooses.
President Trump and interest rates
The U. S. economy is at full employment but with slow economic and productivity growth. Demographics has baked in a large increase in the number of pensioners relative to a shrinking workforce and the crippling impact that the related government entitlement program expenditures will have on the federal budget. Without some changes, these and modest increases in inflation will increase U.S. interest rates. U.S. government bond rates increased dramatically, almost 50 percent in one month, even before the December rate increase by the Federal Reserve and before Trump’s policies have been clarified.
President Trump adds potentially good and bad news to this picture.
The good news is that in December House Kevin Brady, chairman of the Ways and Means Committee, released the outline of a major tax reform plan as part of Speaker Paul Ryan’s “A Better Way” agenda. The plan would, if enacted, introduce a dramatic, growth enhancing reform of U.S. personal and business income taxation. While there are a few differences with the President Trump’s tax reform proposals, it should not be that difficult to resolve them. Prospects for adoption are the best they have been for decades.
The bad news is that during the campaign Trump promised not to change entitlement commitments and proposed increased military and domestic infrastructure expenditures. The Tax Foundation has estimated the additional federal debt from his policy proposals at between $2.6 trillion and $5.3 trillion over the next 10 years. The increase in interest rates needed to finance such deficits could be very large. Optimists expect a relaxation or congressional blockage of at least some of these expenditure increases.
Significantly higher interest rates in the U.S. would attract an increased capital inflow from abroad, increasing the dollar’s exchange rate and the U.S. balance of payments deficit, reducing some of the positive growth impact of a Trump tax reform. An appreciation of the dollar will tend to add net U.S. demand for foreign output but will increase the cost of debt service to those abroad who borrowed weaker dollars. And this is before taking account of whatever the new president might do on the trade front.
Trump’s regulatory reforms
Donald Trump has said that he plans dramatically to reduce the regulatory burden facing American businesses, which currently costs the U.S. economy trillions of dollars. While desirable, deregulation faces numerous challenges.
Reforms to existing regulations must go through a lengthy process and will likely be subject to legal battles from vested interests and NGOs. It is thus important that the new administration carefully identify reform opportunities that are likely to be both successful and meaningful.
Trump has also talked about overturning whole pieces of legislation, including Obamacare and Dodd-Frank. Such reforms will also be very challenging, since they require Congress to pass new legislation. While many in Congress have stated that they support reform, what they do in practice is another matter, in part because the same groups that would object to reforms by the executive wield considerable influence through lobbying.
From the perspective of offshore jurisdictions, deregulation in the U.S. presents both opportunities and threats. Opportunities are likely to exist in the form of new capital investments from funds that focus on industries that have been over-regulated, such as energy and manufacturing. In addition, reform of the Foreign Account Tax Compliance Act and anti-money laundering rules might increase the attractiveness of offshore jurisdictions, deepening the pool of global capital, benefiting both the U.S. and offshore jurisdictions. Threats may come from changes to regulations such as Dodd-Frank and Sarbanes-Oxley that currently make the U.S. a less attractive location for financial services.
The coming clash
President Trump is known as a can-do guy who brings projects in under time and budget. The Washington government establishment is correctly known as cannot-do – in that most projects take far longer than scheduled and end up being far over budget. The president is used to being in control, and is well-known for firing people who fall behind expectations.
Much of the federal work force performs at an unacceptable level as compared to their private sector counterparts. In addition to poor work habits found throughout the government establishment, most of them are politically hostile to the new Trump administration. Voters in the District of Columbia and the surrounding suburbs voted overwhelming for Hillary and against Trump. So, the new president is going to find himself with a bloated, sullen, angry workforce a large number of which are incompetents that are almost impossible to fire.
What the president can do, if the new Republican Congress cooperates, is shut down entire departments of government and then shift whatever pieces that need to be kept to some other agency, or privatize, or contract out the function. However, this process takes time and will be met with fierce resistance. Every activity in the government and all of the personnel and money used to support that activity are the results of lobbying by some interest group, including the government workers, and it will not be easy to overcome all of these political forces who are well-experienced in protecting their turf, no matter how unwarranted.
What the U.S. election means for offshore
While the impact of the U.S. election on international tax law is uncertain, one likely result will be a shift in U.S. cooperation with emerging global trends designed to curb certain forms of tax competition. The predilections of the U.S. president toward tax policy appear to be in various stages of development, with protectionist instincts battling against the fundamental structure of the U.S. economy, built as it is on global trade. Incoming Treasury Secretary Steven Mnuchin has indicated his intention to usher in “the largest tax change since Reagan,” featuring a corporate tax rate cut “to create huge economic growth … and bring a lot of cash back into the U.S.”
But permanently deferring profits results in an effective global tax rate close to zero, so a corporate tax rate cut alone will clearly not suffice; whether the rate cut will be accompanied by carrots or sticks remains to be seen. Some sticks are already on the table. The president has called for punitive tariffs on certain imported goods from selected countries, especially China and Mexico. In addition, House Speaker Paul Ryan has a plan to transform the corporate income tax into something closer to a value added tax, including an exemption for exports and a border tax adjustment, in effect, an excise tax on imports. This is not compatible with WTO rules, but it is not clear that the new administration is concerned about continued compatibility with the global trade regime its predecessors designed. The main idea of the Ryan plan is to disadvantage firms that import relative to those that produce in the United States, including former U.S. firms. At the same time, Ryan understands the United States to be in a global competition for inbound investment capital, a race in which he seeks first place. In 2010, Ryan described the Cayman Islands as “the place to hide your money,” and advocated for a significantly reduced U.S. corporate tax rate, saying, “let’s make this country a tax shelter for other countries instead of having other countries be a tax shelter for America.” But since that time, the trend in the rest of the world is toward curbing, rather than furthering, tax competition: the OECD’s base erosion and profit shifting project, in which the United States played a formative role, is currently in the implementation stage. With the GOP in full control of all levers of government, a shift in tax policy direction away from that project seems likely.
Trump’s offshore impact
First, while most of the attention is focused on President Trump’s proposals for rate cuts in federal taxes for businesses and incentives for repatriation of capital, Trump’s overall strategy seems to be “making a deal.” That suggests any tax bill will be festooned with special provisions, making U.S. taxes more complex. That complexity may offset some of the competitive advantage lower nominal rates provide. Note that Trump has named multiple Goldman Sachs alumni to important economic policy positions, suggesting cronyism has a bright future in Washington.
Second, Trump is introducing considerable uncertainty into international trade deals, promising to repudiate the Trans-Pacific Partnership, renegotiate NAFTA, and so on. That uncertainty will slow economic growth worldwide and probably hurt jurisdictions that focus on facilitating trade.
Third, Trump’s massive infrastructure spending plans – which will be facilitated by his penchant to cut deals and Congressional love of pork – seem likely to cause some inflation by the end of his term. Offshore financial centers thrived in the 1970s by helping investors shield themselves from the ravages of inflation. That business might be looking up.
What does it mean for Cayman?
The Cayman Islands generally watches U.S. presidential elections with a keen interest to ascertain how the new president’s policies will impact offshore financial centers. Like Brexit before it, the Cayman Islands will need to be alive to a high degree of uncertainty and to prepare as best it can even for the unexpected.
How Cayman approaches this task may well depend on the outcome of its own election, which will take place in May 2017. Following recent reforms, there is a level of uncertainty surrounding this election. Will the adoption of a system where effectively the “winner takes all” in each constituency reinforce the power bases of the two main parties? Or, will the relatively small numbers needed to secure victory in a particular constituency favour independents? Some appear to be drawing inspiration from the Trump campaign’s anti-establishment “drain the swamp” rhetoric and it is in this way that the Trump effect could have an immediate impact on Cayman. It is not inconceivable that this process could also manifest in the sort of protectionist, anti-immigration sentiments that evidently fueled both Brexit and Trump. This would represent a challenge, for while the jobs and dreams of the local electorate are critically important, the success of Cayman’s offshore financial services industry is premised on an element of imported expertise and connection rather than protection. It is all the more imperative in the Cayman Islands therefore that we reject at least this aspect of the Trump messaging and seek out common ground and a vision for the future that all see benefit in subscribing to.