tive told me, dismissing the idea that a multi-trillion dollar tax cut for multinational corporations would trickle down throughout the economy and also pay for itself. It’s a view that’s widely shared among the bankers, hedge-fund managers, traders, and quants whose job it is to determine, with Vulcan accuracy, how the Republican tax bill that passed the House yesterday will actually affect the markets. It’s also more than a little ironic, given that the plan was spearheaded by two former senior partners of Goldman Sachs turned Trump shills—Gary Cohn and Steve Mnuchin—a pedigree that has done little to reassure Wall Street veterans who worry that the White House may accidentally nuke the economy in the name of “tax reform.” “Will this be the first tax cut in American history that actually results in a recession?” the executive asked.
It’s a great question. And the House plan provides plenty to be worried about in that regard. Take, for instance, the proposed elimination of the deductibility of state and local taxes. That is obviously a cynical, politically motivated ploy on Donald Trump’s part to penalize voters who didn’t vote for him (for good reason) in high-tax blue states, such as New York and California, and to give a benefit to the red-state voters who did vote for him. (I get it, elections have consequences.) Eliminating the deductibility of state and local taxes is an incredibly divisive plan. “It’s a transfer to red-state wealthy guys,” said the executive, who lives in a blue state.
Worse, he says, it could lead to another housing crisis, just as the last one is (or should be) still fresh in our collective memories. Here’s his thinking (which is hard to refute): Since, generally speaking, one of the largest state taxes is on property—your home—eliminating the federal tax deduction for state property taxes will inevitably cause the cost of homeownership in states with high property taxes to go up. It follows, logically, that if the annual cost of home ownership goes up, then the value of the home—which is for most people their single most-valuable asset—must go down. The National Association of Realtors commissioned a recent study that predicted that the elimination of the deduction for state and local taxes could result in a decrease in home valuations of between 10 percent and 17 percent.
That would wipe out a huge amount of homeowner equity, with the usual expected consequences: the sick feeling that comes from knowing that suddenly you are poorer, which can then lead to lower consumer spending, kicking off a recession. Furthermore, if the value of homes goes down, then whatever equity has been built up in those homes will also go down, and the ability to unlock that equity—through home-equity loans or reverse mortgages—will also decrease. Lower home values could also lead to problems—again—for the government-sponsored entities Fannie Mae and Freddie Mac that have guaranteed some home mortgages, which are secured by homes worth materially less. New problems for the G.S.E.s will make it harder for people to get mortgages, leading to a lower level of home ownership than already exists.
Once upon a time owning a home was the chief pillar of the American dream. (Home ownership rates reached a 50-year low in 2016.) It has proved historically to be a typical American family’s greatest chance for wealth creation. Poof goes the American dream, again.
Wait, there’s more. The House plan of course does not pay for itself. According to the non-partisan Congressional Budget Office, it will add around $1.5 trillion to the federal debt over 10 years. Forget for a moment that candidate Trump repeatedly castigated President Barack Obama for allowing the federal debt to approach $20 trillion—it is now $20.8 trillion and counting, 108 percent of G.D.P., making us the 12th most-leveraged country in the world already—and said that he would reduce the federal debt as president. That clearly ain’t happening. The federal government is the single largest borrower in our country. With interest rates heading up along with the federal debt, that will mean higher interest expense and higher annual budget deficits.
Oh no it won’t, say the trickle-down economic hawks such as Cohn and Mnuchin, aided and abetted by the tired Reagan-era economists Stephen Moore and Larry Kudlow. What will happen, they say, is that the tax cuts will unleash our collective animal spirits and put G.D.P. growth on a much-higher trajectory, generating an additional $1 trillion in tax receipts over 10 years to partially offset the cost of the tax cuts. Federal tax receipts in 2016 were $3.27 trillion, or 17.5 percent of 2016 G.D.P. of $18.6 trillion. In order for tax receipts to generate another $1 trillion over 10 years, G.D.P. would have to grow on the order of another 2.5 percent per year, compounded for 10 years. In other words, the United States economy would have to grow at around 5 percent annually for the next 10 years, in line with emerging economic powerhouses China and India. Guess what sports fans? That’s not happening, especially in an economy that has already supposedly been benefiting from absurdly low interest rates for close to a decade, and that is already at or near structural full employment.
Sure, there are some goodies in it for Wall Street’s clients, which might end up being good for them, too. Cutting the corporate tax rate to 20 percent from 35 percent should generate higher corporate profits—not that generating corporate profits has been much of a problem lately—that should translate into even higher stock prices, which would benefit shareholders (including Wall Street bankers and traders) and that might result in more investment banking business, which tends to be correlated with growing C.E.O. confidence. Talk about trickle down! The reality is that few corporations have been paying taxes at a 35 percent rate, so lowering them to 20 percent may not change their bottom lines much. Furthermore, the expected corporate tax cut has already likely been baked into the stock market, which is trading at or near all-time highs. In fact, as details of the tax plan have come out in recent days, the stock market has pulled back a bit. My guess is that it has found its highs for the time being.
Then there is the tax holiday that corporations will get if they choose to repatriate some or all of the $2 trillion or so held overseas. Having drunk the Trump Kool-Aid by now, Cohn tried out some of the Trump mind games on a group of C.E.O.s at a Wall Street Journal conference the other day. They didn’t fall for it. He asked them for a show of hands as to whether the tax plan would lead to higher corporate investment. A few hands went up but fewer than Cohn had expected. “Why aren’t the other hands up?” he asked. They’re not up, Gary, because it’s obvious to them, and many of the rest of us, that trickle-down economics is a myth.
If Cohn were being more honest, he’d admit what most chief executives are saying privately, and some publicly. “The Trump team is arguing that massively cutting taxes for corporations will somehow translate into significant wage increases for working people,” David Mendels, the former C.E.O. of publicly traded software company Brightcove wrote last week. “This argument fundamentally disregards everything we know about how companies actually decide to hire and how much to pay their employees. As a C.E.O. (and in previous roles) I was involved in hiring and determining salaries for thousands of people over 25 years. From real-world experience I can tell you that tax rates literally never came up in any discussion about hiring or pay levels.” Occam’s razor, he added, is the best rubric to predict what will happen when you give investors more money in the absence of increased demand: they’ll keep it.
Howard Schultz, the billionaire executive chairman of Starbucks, was more blunt: “This is not tax reform,” he said at the DealBook conference in New York last week. “This is a tax cut. It’s fool’s gold that he wants to take the corporate tax rate from 35 percent to 20 percent. For what purpose? Is that profit going to go back to the people who need it the most? Is that going to help half the country that doesn’t have $400 in their bank account for a crisis? No.”
Executives know there’s no mechanism in the G.O.P. tax plan to reward them for passing those savings along to their employees, who Paul Ryan has estimated would get an average $4,000 raise (over a decade) as a result of corporate largesse. The labor market has tightened considerably—the unemployment rate is at a 15-year low—and the stock market is starting to level off. The word on the street, though, isn’t that higher corporate profits will lead to higher wages; rather, it’s all about buybacks: Goldman says stock buybacks will hit $590 billion in 2018, while Merrill Lynch predicts half of all repatriated cash would go to buybacks or acquisitions. It’s a sugar high that might extend the market rally temporarily, but will deepen the rot in our economic cavity.
There is one bright spot in the Trump tax plan for Wall Streeters: the proposed elimination of the estate tax. While the estate tax snags only around 5,000 estates per year—which applies to estates with a fair market value greater than $11 million, for married couples—eliminating the estate tax completely will be of some benefit to bankers, traders, and executives, many of whom do have a net worth in excess of $11 million. “That’s great,” my Wall Street friend said, “but I’ll be dead by then.”