Global Macro Strategy

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

November 29, 2016

Craig Holke, Global Research Analyst
Paul Christopher, CFA, Head Global Market Strategist

The Crosscurrents of Economic Agenda on Growth

  • President-elect Trump has proposed economic policies that include tax cuts for both individuals and corporations, increased government spending on infrastructure, and the renegotiation of trade deals and possible implementation of tariffs.
  • These policies have individual pros and cons. Yet, they also should be examined in terms of how they interact and potentially offset each other.

What it may mean for investors

  • These policies should have wide-ranging impacts on the economy and markets. While specifics are unknown at this time, it is important for investors to understand the effects these policies may have.

President-elect Trump and Republicans in Congress are in the midst of prioritizing their legislative agenda. Several of the more high-profile options being discussed have the potential to significantly affect economic growth. In this report, we examine the possible economic implications of proposed individual and corporate tax cuts, increased government spending and trade-related policies. In addition to looking at the pros and cons of each policy, it is also very important to look at how they potentially counteract each other. The effect of these crosscurrents can have a significant impact on the economy and markets.

The Effect of Tax Cuts and Stimulus on Economic Growth

President-elect Trump has proposed to cut federal income taxes for both individuals and corporations. Conceptually, cutting taxes should raise growth. Yet, the exact relationship between, and strength of, these changes depends on various factors. For example, the economic-growth benefit of cutting taxes may be offset by other factors, including revenue lost to the government and what individuals actually do with this extra wealth. One common perception is that tax cuts for the individual lead to increased consumer spending and provide stimulus to the economy. Due to our current progressive tax system of charging higher tax rates at higher income levels, the effect of tax cuts is not the same for all individuals. Tax cuts for those on the lower end of the income spectrum generally result in greater levels of direct spending that flows through to economic growth. Yet, as income levels rise, a greater proportion of the increased wealth due to tax cuts has historically been saved instead of spent. Depending on how this wealth is saved, greater investment may be achieved, which may benefit the economy in the longer term but at the expense of the desired short-term stimulus.

According to data from the Organisation for Economic Co-operation and Development (OECD), the U.S. currently has the highest level of corporate tax rates among developed nations. Chart 1 shows that U.S. corporate tax rates have lagged those of the main industrialized competitors to the U.S. economy in terms of rate reductions. In the 1980s, Congress reduced the corporate rate to gain a competitive edge, but U.S. competitors have since lowered their rates by more. Deductions will likely be reduced to keep the actual revenue received by the government somewhat neutral.

Chart 1. U.S. Corporations Face the Highest Tax Rates Among Developed CountriesChart 1. U.S. Corporations Face the Highest Tax Rates Among Developed CountriesSources: Organisation for Economic Co-operation and Development (OECD), Wells Fargo Investment Institute, 11/25/16. Annual data, from 1981-2016. The OECD is a group of 35 members dedicated to economic development. It includes many of the world’s developed countries in Europe and North America but also emerging markets such as Mexico and Turkey. The chart shows the average combined federal and sub-central (e.g. state) corporate tax rate for the United States vs. the average for the remaining OECD countries.

President-elect Trump has proposed a large infrastructure spending plan to replace the aging infrastructure in the United States. Infrastructure investments, such as in transportation, could increase productivity and provide a boost to the economy. Funding this investment through deficits will have an offsetting effect by increasing the level and cost of federal debt. If investors demand higher yields to compensate for the greater levels of debt, then borrowing costs could rise across the economy and slow economic growth. Also, taxes might be raised and government spending cut to narrow the deficit, at some later date. On balance, tax cuts and additional spending could support faster growth in the coming year or two, but the longer-term economic impact should depend on how aggressively the government’s budget deficit widens.

Tariffs and a Reduction in Trade are Negatives for the Economy

President-elect Trump also proposes the renegotiation of existing trade deals and possible implementation of tariffs against those deemed to be conducting unfair trade with the U.S. While trade protections for particular industries may protect jobs in those industries, the effect on the broader economy is likely to be negative. First, relying more on domestic production than global sourcing probably will raise demand for domestic resources and register as higher inflation. Also, an increase in tariffs by one party is frequently met by an increase in tariffs for the opposing party, with the potential for a cycle of retaliation. Finally, the negative effects could extend to U.S. companies that serve mainly domestic customers. Over the past three decades, U.S. businesses have increased their reliance on a global supply chain. Domestic U.S. mid-sized and small companies also may face increased costs and a reduction in profits as a result of these policies.

Investment Implications

Due to the uncertainty over how these policies will be enacted, and the potential for positive and negative crosscurrents, we maintain our 2017 U.S. economic-growth forecast of 2.1 percent. We believe that the main risks to our forecast come from the timing or sequence of policies. Economic growth in 2017 could be higher than our forecast, if some of the positive elements are implemented first, but growth could be lower if the more negative aspects receive priority. With these risks in mind, we will monitor policy announcements and will provide updates as decisions are made and their economic and market impacts are evaluated. In the meantime, we continue to recommend that investors maintain discipline and follow their investment plan. Looking ahead, the key factors to watch will be (i) how quickly Congress approves tax cut and spending plans, (ii) by how much the deficit will widen, (iii) how aggressively the administration imposes new trade restrictions, and, of course, (iv) whether any economic benefits can offset inflationary impulses.

Risk Factors

All investing involves risk including the possible loss of principal. There is no assurance any investment strategy will be successful or that a fund will meet its investment objectives.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by GIS. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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