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Can President Trump Reshape the U.S. Economy?

From one perspective, the election of the first modern president who has never held elected office, filled a top government position, or achieved a high military rank represents a historic moment. While the popularity of candidates from the private sector has increased dramatically in recent election cycles, only President-elect Donald Trump has made it to the country's (if not the world's) top job.

His election was the culmination of countless hours of hard work and dedication in a run for office that was as rough-and-tumble as any in recent memory. And yet it marks only the beginning of a level of labor that could make the campaign seem like a picnic in the park.

In January, President-elect Trump will begin leading a country that has been deeply divided for more than a decade. It's fair to say the battles over such things as the Affordable Care Act, the Supreme Court vacancy left by the death of Justice Antonin Scalia, immigration, trade, and the country's place in a world increasingly susceptible to terrorism have been contentious at their best, and downright vitriolic at their worst. Much of this animosity stems from Americans' frustration with an economy whose recovery from the Great Recession has been uneven and altogether slower than any expansionary period of the last half-century.

While job gains have been steady and headline unemployment is half of its postrecession peak, low labor-force participation masks some underlying weakness, and wages have yet to rise commensurate with job growth. While consumer spending has strengthened and the housing market has rebounded nicely, businesses remain cautious, keeping capital expenditures low. And while the possibility that the U.S. will soon slip back into recession is, in our view, still remote, a benchmark interest rate near zero gives the Federal Reserve little room to maneuver using conventional monetary policy should the economy again suffer a contraction.

Against this backdrop, President-elect Trump will likely make progress only slowly--even with a Republican majority in both houses of Congress. Indeed, history dictates that very few presidents' campaign pledges make it into law as originally shaped, and that may be truer than ever now that compromise seems to have become a dirty word on Capitol Hill. The new president will need to reach across the aisle to Democrats, many of whom have already promised their constituents to obstruct him at every turn. Within his own party, there are a number of lawmakers who support free trade and who likely won't respond favorably to his isolationist talk. Here, he may receive a lot of support from Democrats who have traditionally disliked trade deals such as the Trans-Pacific Partnership (TPP).

Nonetheless, S&P Global Ratings believes President-elect Trump has an opportunity to bolster the world's biggest economy in a number of ways, including tax reform, increased investment in infrastructure, and energy policy, just to name a few. Here, we briefly outline our views on the issues we think will occupy much of the new president's time in the White House, and how he has suggested addressing them.

Fiscal Policy

During his campaign, President-elect Trump has said he plans to lower taxes in a number of ways, including collapsing the current seven federal income-tax brackets to three, with lower rates. His proposals would do this while repealing the alternative minimum tax and reducing the corporate tax rate to 15%, from today's 35%. One of his early proposals reportedly would have diminished federal tax revenues by more than $10 trillion; his later proposal would do so by a smaller $5.8 trillion, according to the Committee for a Responsible Federal Budget (CRFB). The national debt is currently more than $14 trillion, or near 77% of GDP, and the CRFB estimates that the new president's plan would add an additional $5.3 trillion over the next decade. He argues that lower taxes would boost private-sector incentives.

The plan would reform the individual income tax code by lowering marginal tax rates on wage, investment, and business income. Furthermore, it would broaden the individual income tax base. In addition to lowering the corporate income tax rate to 15%, the plan would modify the corporate income tax base. Finally, he has said he would eliminate federal estate and gift taxes.

President-elect Trump's plan favors high earners, with the top 1% getting about 47% of the tax cuts, according to the Tax Policy Center. Compared with the middle class and poorer Americans, high-income households save a greater portion of their income than they spend. Therefore, the effect on overall consumer spending would likely be less than if a tax cut was targeted to low-income households, who historically spend more of what they receive.

The new president has also said he supports increased infrastructure spending and vowed to increase defense spending and child-care assistance, while stopping cuts to Medicare, Medicaid, and Social Security. However, the revenues potentially lost to the government from his proposed tax cuts would likely mean either less money for the government to spend or a widening federal budget gap.

It's worth noting that all of this comes as the government's borrowing limit (so called "debt ceiling") is set to run out in mid-March, and that the often toxic environment on Capitol Hill has in the past raised the risks that any resolution will be dragged out until later in the year. As such, the Treasury Department could once again need to conduct various "extraordinary measures" to postpone the need to raise the debt ceiling until Congress can reach a compromise. (To complicate matters, Fed Chairwoman Janet Yellen's term will end in February 2018.) That said, the Republican majority in both halves of Congress diminishes this likelihood--though we may still be in for a bumpy ride..

Tax Reform

Much of the debate about the need to overhaul the U.S. tax code has focused on historically high income inequality and the need to "make the wealthy pay their fair share of taxes." And rightfully so: Income inequality in the U.S. has been increasing for the past several decades. According to the Organization for Economic Cooperation and Development (OECD), the average income of the richest 10% of Americans is 19 times that of the poorest 10% (as of 2014), meaning the U.S. ranks third in income inequality by this measure among advanced nations, with only Mexico and Chile having more unequal income distributions. We believe this level of income inequality is weighing heavily on U.S. GDP growth.

S&P Global Ratings agrees, conceptually, with recent talk across the party lines of using tax revenue to invest in infrastructure. We have proposed a major step in U.S. tax reform that would give American companies a window in which to repatriate funds at a zero tax rate, with a commitment that they invest 15% of the money in infrastructure repair and refurbishment (see "Rebuilding Through Repatriation: How Corporate Cash Can Save America's Infrastructure," published Oct. 5). Toward this end, Democratic New York Senator Charles Schumer said in an interview with Bloomberg News on Nov. 7 that there is "a possibility of compromise for international tax reform provided it's attached to a broad, strong infrastructure bank."

Either way, it's evident that a tax code that has gone effectively unchanged in 30 years--and was designed for a manufacturing-heavy economy rather than today's service- and technology-oriented one--is in dire need of reform. It's clear just how onerous and outdated the tax code is when we consider that it is keeping American corporations from repatriating the more than $2 trillion they hold overseas (the Government Accountability Office [GAO] now estimates untaxed offshore earnings are $2.6 trillion).

Most major countries tax their companies only on profits they earn at home, with foreign earnings subject to the rates of the jurisdictions in which they operate. American firms, by contrast, pay U.S. taxes on income generated anywhere in the world, while generally being allowed to defer taxation on foreign earnings by parking the money overseas. And American companies pay some of the highest tax rates in the world. At 35%, the U.S. federal statutory corporate tax rate is higher by half than the EU average top corporate tax rate of approximately 22.5%. (That said, large multinational U.S. corporations rarely pay the top federal tax rate of 35%; in fact, the average effective U.S. corporate tax rate was about 14% from 2008-2012, according to the GAO.)

During his campaign, President-elect Trump said that he would "eliminate job-killing regulations" and "have massive tax reform and simplification." He has discussed offering corporations a one-time tax holiday to entice American firms to repatriate some of the more than $2 trillion (and hundreds of billions of dollars in potential tax revenue) sitting outside the U.S.

Both Sen. Schumer and Rep. Paul Ryan of Wisconsin, the Republican speaker of the House, have expressed their support for broader tax reform that would channel funds toward infrastructure investment. But while there is bipartisan agreement among key senior policymakers on the need for tax reform, the details on what that would look like will almost certainly complicate matters.


One issue the president-elect has been clear on is the need for increased infrastructure spending--something lawmakers on both the left and right have supported. Few would argue against the need to repair and refurbish the roads, bridges, water systems, and rail networks that the American Society of Civil Engineers grades a 'D+'.

As we have noted many times, the "multiplier effect" of infrastructure investment on the economy can be sizable (see "Global Infrastructure Investment: Timing Is Everything (And Now Is The Time)," published Jan. 13, 2015). S&P Global Ratings economists estimated last year that, under certain conditions, every dollar of investment in infrastructure could add as much as $1.70 to GDP in just a few years, depending on the state of an economy (with multipliers tending to be lower in a strong economy and higher in a stagnant or struggling one). And while the multiplier effect would likely be slightly smaller today because of where the U.S. economy is in the business cycle, it remains substantial, at around 1.2x. We estimate that an additional $500 billion in spending (spread evenly over eight quarters) would be fully returned to the economy within the first 36 months, and add at least $592 billion to GDP in just the first few years.

Additionally, it would create roughly 881,000 infrastructure-related jobs in the first two years. Aside from the near-term boost, the economy's productive capacity and output would also likely increase once the infrastructure is built and absorbed into the economy--adding jobs long after the initial effects have subsided. However, whether the money comes from public coffers or private interests, it's crucial that spending is managed reasonably. Too often the primary criteria for a project's approval are political support and visibility, rather than more prudent cost-benefit analyses. We believe that focusing on projects with the most advantageous returns is critical.

Trade And Immigration

Clearly, the TPP garnered most of the trade-related headlines during the campaign--and President-elect Trump has taken a hard line on trade. He has called for tariffs of 45% for China and 35% for Mexico--which means that American consumers now paying $100 for an import from either of those countries could pay $145 and $135, respectively. He has also said he would punish U.S. companies that move production overseas. (Currently, the U.S. doesn't impose any tariffs on Mexican imports, keeping to terms of the North American Free Trade Agreement [NAFTA]. And while some Chinese goods such as steel are subject to import tariffs, the trade-weighted average import tariff is about 2% on industrial goods, according to the Office of U.S. Trade Representatives.)

Either way, the unbridled criticism of almost any and all trade agreements from both parties is at odds with history, given that Republicans have traditionally supported free trade, and President George H.W. Bush negotiated the terms of NAFTA (which was signed into law by President Bill Clinton).

We believe the sluggish economic recovery, which has only recently brought about stronger job gains and a pickup in wages, may help explain the virulent response to free-trade proposals--the fear being that Americans would lose more jobs overseas. But that argument ignores the benefits U.S. consumers would see in the form of more product choices at lower prices, which would help lower-income households most. Given all the talk about how the recent recession and slow recovery has had an outsized detrimental effect on those at the lower end of the income ladder, this positive result should not be undervalued.

In our view, the cost of increased isolationism would far outweigh the benefits of protecting American businesses in such a manner. In other words, if each country specializes in a good where it has a comparative advantage and trades for the rest, both world production and consumption improves. From an economic standpoint, with regard to President-elect Trump's stance, a number of proposals are unlikely to reach implementation, either because of legal reasons or a lack of political support. Nonetheless, a provision of the Trade Act of 1974 gives the president the fast track authority "to retaliate (with selected protection) against any country found to maintain unfair, unreasonable, or discriminatory practices that restrict U.S. exports." Any action along these lines increases the risk of a broader trade war, which we think would have dire economic consequences for the U.S. and the world.

Relatedly, it's our view that employment-based immigration reform would represent a significant positive development for the U.S. economy.

President-elect Trump's proposals on immigration include building a wall along the Mexican border and deporting millions of undocumented immigrants. Our previous analysis on U.S. immigration policy notes that, in addition to the cost of deportation, the effects of tighter immigration laws would be quite dramatic at a time when the country has a rapidly aging labor force. We think the mass deportation of undocumented workers would weaken already slow-growing U.S. productivity, and result in slower near-term economic growth.

The president-elect argues that the H-1B program--which offers non-immigrant visas for specialized workers--costs Americans jobs, and he has called for raising the prevailing wage paid to H-1Bs, saying this could help push companies to give these coveted entry-level jobs to the existing domestic pool of unemployed native and immigrant workers in the U.S. instead of flying in cheaper workers from overseas.

Workers coming to the U.S. on H-1B visas are often working in specialized science, technology, engineering, and math (STEM) research jobs, which are considered very difficult to fill. And while immigrants will overlap at times, we found that they often fit into the labor force in areas and occupations where there are insufficient numbers of comparable native workers, both for high- and low-skilled occupations. In other words, they are largely complements, not substitutes, to the American workforce. So if H-1B visas are issued for jobs that are difficult to fill with American workers, then raising the wage requirement for H-1Bs wouldn't encourage the hiring of American workers. It would probably just raise business labor costs for those H-1B workers.

We previously estimated that employment-based immigration reform could add about 3.2 percentage points to real GDP over 10 years. Generally, highly skilled workers earn much higher than average U.S. wages, with those in the STEM fields earning almost twice the average. The benefits become yet clearer when we consider that the top 20% of earners account for 38% of all spending (see "Adding Skilled Labor To America's Melting Pot Would Heat Up U.S. Economic Growth," published March 19, 2014). Immigrants are also much more likely to file a patent than U.S.-born citizens are. They're often highly entrepreneurial, too--reportedly 30% more likely to start a new business than U.S.-born citizens. This in turn, creates more jobs.

Additionally, a younger workforce adds to tax revenue. If, as we estimated, immigration reform were to add 3.2 percentage points to GDP in the first 10 years (and likely even more in the following decade) increased tax revenues would help shrink the cumulative federal deficit by about $150 billion in real terms.

Minimum Wage

President-elect Trump initially opposed any increase in the minimum wage but has since expressed interest in increasing it. The official Republican platform makes scant mention of the minimum wage, saying only that it "should be handled at the state and local level."

S&P Global Ratings believes that workers with weak bargaining power are in increasing danger of being left behind as the economy continues to recover, mainly because the minimum wage is failing to meet at least one of its goals: to augment purchasing power of low-wage workers (see "Giving America A Raise (In The Minimum Wage) Would Foster Inclusive Growth," published Sept. 14, 2016).

In any event, there's little dispute that the country's minimum wage is comparatively quite low at just 36% of the U.S. median wage (and trending lower). This is far below its peak of 55% of the median wage in 1968 and ranks last among the 35 OECD countries. In fact, the U.S. minimum wage would be about $10 if it were at 55% of the prevailing median, and a little more than $12 if taken as a proportion of prevailing mean wage. On top of that, it were indexed to inflation starting in 1968, the minimum wage would now be $11.

Just as regular maintenance of our infrastructure helps bolster economic productivity, we see raising the minimum wage as ultimately beneficial to the economy. And conditions are favorable for this to occur. Given its relatively low level and the fact that the U.S. business cycle isn't in a downturn or the initial stages of a recovery, businesses shouldn't have more difficulty digesting the extra cost. Moreover, recent empirical evidence suggests that the main argument for holding the wage where it is--that there would otherwise be massive job losses--is specious.

Interest Rates

One area in which President-elect Trump will have little direct influence, but which will surely be on his radar, is the future of U.S. interest rates. S&P Global Ratings expects long-term borrowing costs to remain lower over the 10 years or so than they were, on average, in the two decades leading up to the Great Recession because of factors related to lower potential output and changing savings and investment preferences. Fed policymakers are meant to act on its key macroeconomic objectives independent of political pressures. Still, it would be naive to think that the new administration wouldn't like to see benchmark rates return to normal (or, at least, closer to normal), if only as an indication that central bankers believe the economy is on surer footing.

The decline in long-term rates in the U.S. (and globally) in the past quarter-century reflects a number of macroeconomic conditions, some protracted and some transitory. While the monetary- and fiscal-policy responses to the recent financial crisis have played important roles in pushing long-term rates to today's historically low levels, real rates were already declining. (See "U.S. Long-Term Interest Rate Looks To Stay Low For Longer," published Nov. 3, 2016.) Increased global savings, a shortage of "safe" assets, shifting demographics, less global demand for investment, and changes in productivity growth have all contributed to this trend. We believe that many of these forces will linger longer or unwind only partially in the coming years.

In this light, the real interest rate on 10-year government debt may settle at a full percentage point lower than it was before the financial crisis. In the longer term, the nominal yield on the 10-year Treasury (used as a base for other borrowing costs, such as mortgage rates) is likely to reach 3.5%, when the underutilization of economic resources dissipates and assuming 2% inflation. To the extent President-elect Trump's expected increase in public spending is debt-financed, all else equal, this has the potential to boost near-term growth and expected inflation while also reversing some downward pressure on government bond yields near term (because of increased supply of these bonds and higher expected inflation).

Still, the absence of imminent supply-side reforms means the economy faces the increasing likelihood of being trapped in a period of low growth for longer than it seemingly should. The larger risk is that sluggish aggregate demand and weak productivity growth will continue to erode productive capacity, with policymakers unwilling or unable to address this crucial issue (see "The Strange Case Of Shrinking U.S. Productivity Growth: Myth, Mismeasurement, Or Multiyear Phase?," published May 5, 2016). To this point, President-elect Trump's proposed lower corporate taxes and full expensing of capital costs could boost growth rates of business investments, and in turn, productivity and potential GDP in the long run (all else equal).

While Hurdles Abound, Opportunities Can Be Found

That President-elect Trump has a long row to hoe with regard to enacting his economic proposals seems self-evident, especially given the mood of Americans struggling to succeed in an economy still recovering from the Great Recession. The difficulty he will likely face in persuading his opponents on the left (and many in his own party) to push through his plans will make the already-difficult job of governing especially challenging.

That said, the new president has an opportunity to enact economic reforms that could have effects lasting for a generation or more--and we think the Republican majorities in Congress will help him in many respects. Whether this will be enough remains to be seen, but one thing is certain: The truly hard work begins Jan. 20.