This is the worst possible time for unfunded and ideologically-driven tax cuts. Will the Republican fiscal wreckers see sense?by George Magnus / February 6, 2018 / Leave a comment
Trillion dollar budget deficits now loom in the United States. At 5-5.5 per cent of GDP, these will be the highest peacetime deficits since the end of the second world war, save only for the deep recession periods of 1981-83 and 2008-09.
While age-related Federal spending is the structural problem which Congress hasn’t addressed, tax cuts for companies and the better off are the current cause for concern about the budget. We can argue the merits of variants of overdue tax reform, but this is the worst possible time for unfunded and ideologically-driven “supply side” tax cuts.
You can see how trouble might be brewing for financial markets—and for the economy—by looking at what happened last week.
After a surge in the US stock market, for which President Trump and Republican law-makers were quick to take credit, the Standard and Poor’s 500 index dropped by just over 2 per cent last Friday, and over 4 per cent in the week, the largest weekly fall for two years. Yesterday, the market dropped another 4.1 per cent—the second biggest points plunge in history.
Yet the stock market fall was most likely noise, especially given the still feisty earnings being generated by US companies. But look a little deeper.
Understanding the fall
The proximate reason for the stock market’s wobbling has been the rise in bond yields. The US government’s 10-year borrowing rate closed last Friday at 2.84 per cent, up 40 basis points since the turn of the year, twice the level of last summer’s trough and the highest it has been since late 2013.
This move, the mirror image of what normally happens to stock prices, has persuaded many that the bonds have changed from a trading to a trending market (down, since prices and yields are inversely related). There are two reasons for this.
First, the economy is doing pretty well, as suggested by the January jobs report. Average hourly earnings growth rose to a respectable 2.9 per cent. Earnings growth for production and non-supervisory workers didn’t budge from 2.4 per cent, and total hours worked slipped, but markets saw enough in the report to expect the Federal Reserve to raise interest rates again soon.
Second, the Tax Cut and Jobs Act, recently passed by Congress and signed by the President…