When Washington lawmakers return from their August recess, they'll have a lot to do. The collapse of Republicans' plan to "repeal and replace" the Affordable Care Act (ACA) has dealt a heavy blow to President Donald Trump's ability to turn any of his campaign pledges into policy (which, to be fair, is difficult to do at the best of times). While GOP lawmakers now may be able to focus elsewhere, broad agreement on almost any issue may prove elusive, despite the party's majorities in both the Senate and House of Representatives.
In this light, S&P Global Ratings believes the prospects for promised pro-growth plans are, in a word, dim. We no longer believe the federal government will be able to push through even a small infrastructure-spending package--much less the $1 trillion the White House has suggested. And while recent talk on Capitol Hill about some lawmakers finally reaching across the aisle is encouraging, we expect only moderate tax cuts of $500 billion, rather than true tax reform, to be passed early next year as midterm elections approach.
Despite the hurdles, the world's biggest economy continues to rumble along in its recovery from the Great Recession.
We expect the current expansionary period--now in its ninth year and the third-longest since World War II--to continue into 2018, albeit at a modest pace. We forecast real GDP growth of 2.2% this year and 2.3% next year, as the labor market continues to strengthen and the Federal Reserve is likely to apply the brakes only lightly, with a measured response to monetary-policy normalization in light of tame inflation. The 1.9% average annualized growth for this recovery is just over half the 3.5% historical average annual growth rate (1947 to 2007). It's not much higher than the economy's lower long-term potential growth rate, which we now estimate at 1.8%.
Looming over all of this is the chance that the current stasis could hinder progress on crucial legislation that would increase the federal borrowing limit and establish federal spending priorities once the fiscal year ends on Sept. 30. While this raises the possibility of a government shutdown, with Republicans in control of Congress and the White House, we think lawmakers will come to their senses and avoid such a fate. Still, the ongoing debate about the debt ceiling weighs on the economy and is incorporated in S&P Global Ratings' 'AA+' sovereign rating.
At any rate, there are a number of areas that lawmakers will have to tackle after their break if they want to help the president deliver on his campaign promises in any measurable way.
Tax Reform: Will The Middle Class See The Color Of Money?
President Trump's inability to rally Republicans around "repeal and replace" may reverberate into other areas--specifically tax reform. Lacking a repeal of the ACA, lawmakers face a narrower fiscal space in which to work--a repeal of many ACA provisions would have decreased deficits by $473 billion from 2017 to 2026, according to the Congressional Budget Office. We believe this makes it much harder to craft a debt-neutral (or near-neutral) plan to implement a 15% corporate tax rate, as the president has suggested. (The GOP House Ways and Means Committee have targeted a rate of 20%.)
S&P Global has long believed the U.S. tax code is in dire need of an overhaul if the country is to compete effectively with its global competitors. However, the administration's current tax plan would raise federal government debt to 111% of GDP by 2027, from the current 77%, and cost the government roughly $5.5 trillion in lost revenue over that time, based on Tax Policy Center scores. The House GOP "Better Way" tax plan would cost $2.3 trillion over a decade, based on estimates by the Tax Policy Center. As for the argument that faster economic growth would largely offset the plan cost, historical evidence proves otherwise, meaning support would be hard to come by. And while S&P global has argued that permanence is key to making tax reform effective, without bipartisan support, any package, if approved, will likely sunset in a few years, leaving the U.S. back where it started.
Given these factors, we believe that Congress will not achieve tax reform and will instead pass a tax cut. We believe this will not happen until 2018 and will be modest at best, with only $500 billion of cuts with roughly equal shares to households and corporations. While this will no doubt still be well received, as all tax cuts are, the question will be duration and degree. Nonetheless, any cut will still fall short of the President's campaign promise of tax reform, again showing us promises are not policy, and will not be enough to spur economic growth to reach 3%, and 4% will continue to be out of reach.
Infrastructure: The Country's Mean Streets Are In Need Of Repair
At this point, President Trump's plans to address the country's crumbling infrastructure, including the American Energy and Infrastructure Act, which is designed to leverage public-private partnerships and private investments through tax incentives to spur $1 trillion in investment over 10 years, are on hold.
And with no fix, it's hard to see how the barely passing grade of D+ from the American Society of Civil Engineers will be lifted any time soon. So, all those potholes, airport delays, congested interstates, and clogged cyber-highways will not be a thing of the past.
While our view on the need for massively increased infrastructure spending is well documented, the benefits largely come down to timing. The so-called "multiplier effect" of infrastructure investment on the economy in the short run can be sizable, but, as the economy strengthens, it lessens. In January 2015, we estimated that every dollar of investment in U.S. infrastructure could add as much as $1.70 to U.S. GDP in just a few years. By last October, we estimated that the multiplier had narrowed to 1.3--meaning that every $1 spent on infrastructure would generate $1.30 in economic growth over the duration of the project and has softened further since then, as the economy continues to strengthen.
Over the long run, productivity enhancements from infrastructure investment, if spent wisely, can help boost growth and create even more jobs in the future. By means of explanation, the Eisenhower interstate highway system, authorized in 1956, cost about $500 billion in 2016 dollars. Sixty-one years later, that infrastructure investment is estimated to have returned more than $6 in economic productivity for each $1 it cost. Indeed, with all the product and people safely transported on these roads at any point in time, it's easy to say that it paid for itself.
With this in mind, we were encouraged by the possibility that President Trump was considering using proceeds from a repatriation tax holiday to help fund his infrastructure initiative. From an economic point of view, we're looking at the long-term growth potential to the U.S, with this being one way to kick-start growth.
But as the economy continues to rumble along and the job market tightens, the short-run multiplier effect of an infrastructure investment will continue to diminish. And, given the myriad other distractions in Washington, we believe it's less likely that infrastructure projects come to fruition and provide any sort of economic stimulus and consequential benefit. Therefore, we do not include it as a factor in our forecast for economic growth in 2018.
Deregulation: Will The Wolf Of Wall Street Howl Again?
One pro-growth area in which the 45th president has found some footing involves deregulation. And, in many ways, this has been the most effective way to accomplish a number of consequential measures without the need to rally a majority of lawmakers.
Shortly after taking office, President Trump signed an executive order requiring federal agencies to form deregulation teams. In the months since, in addition to loosening regulations with regard to the environment and agriculture, the White House has joined lawmakers in taking aim at the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which regulates various aspects of the banking system in an effort to prevent a financial crisis similar to the one that preceded the Great Recession.
Toward this end, the House voted in June to approve the Financial CHOICE Act (FCA), which the Senate has yet to vote on. Republican Mike Crapo of Idaho, chair of the Senate Banking Committee, has said lawmakers are hoping to work with Democrats to forge their own bill to offer "regulatory relief" for Wall Street and community banks that would be able to clear the 60-vote threshold.
But deregulation may prove more difficult than many imagine, as many of the positions needed to move legislation through the process remain unfilled. For example, the Securities and Exchange Commission (SEC), responsible for proposing securities rules and regulating the securities industry, should have five members--but, because only three commissioners are currently in place (two Republicans and a Democrat), a single member could refuse to make a quorum and delay any rule changes.
While upbeat confidence readings signal that American companies believe the administration's pro-business philosophy will at least ensure that no new onerous regulations are on the horizon, the question is duration. How long will they sustain these feelings without other supporting economic stimulus? While we see this confidence as an economic positive, it is too early to tell whether this will have lasting impact beyond helping strengthen the job market. We can't say if it moves the needle in terms of our view of projected economic growth at this time.
Trade: Turning The U.S. Into Shutter Island
President Trump has repeatedly railed against what he sees as unfair practices perpetrated by the U.S.'s major trading partners--practices, he says, that are allowed under the cover of free trade. On his first day in office, the president withdrew the U.S. from the Trans-Pacific Partnership, and he has since formally notified Congress of the administration's intent to renegotiate the North American Free Trade Agreement (NAFTA)--a move that would fulfill a widely popular campaign promise among Trump voters.
The sluggishness of the ongoing economic expansion, which has only recently brought about significant job gains and higher wages, helps explain voters' virulent response to free trade. Unfortunately, this ignores the benefits that American consumers reap in the form of more product choices at lower prices. While we recognize NAFTA may be responsible for the loss of some American jobs and stagnation in real wages--particularly in manufacturing--trade in goods among the U.S., Canada, and Mexico has tripled since the agreement took effect in 1994, with cross-border supply chains making American firms more competitive.
Moreover, our assessment of the effects of the treaty on Mexico and the U.S. determined that net gains have accrued to both countries. In the end, we see the cost of increased isolationism as far outweighing the benefits of protecting American jobs and businesses in such a manner.
That's not to say it's all smooth sailing on the global trade front.
The administration has raised the specter of invoking national-security interests to erect barriers to imports. (Note that World Trade Organization rules include a national-security exemption designed to be used only in times of war.) Either way, the effects on trade flows would depend on how hard the administration's protectionist stance is. The administration appears set to impose broad tariffs on all steel imports (hard protection) or to set up a system of quotas and tariff barriers that would essentially freeze imports from particular countries at current levels and charge tariffs on levels above the quota (soft protection). Earlier, the U.S. Department of Commerce announced its intention to impose preliminary countervailing duties on Canadian softwood lumber imports. Tariffs on Canadian softwood lumber will help U.S. logging companies when they compete with their foreign counterparts. But Canada accounts for around 30% of the U.S. softwood lumber market, with homebuilders its major client. Reduced supply at higher prices means a higher price tag for new homes, which have already risen 52% since it bottomed in October 2010, based on U.S. Census data.
The hard-tariff route could provoke a messy scenario in which the U.S.'s trade partners feel compelled to either impose their own national-security restrictions on steel imports, or to retaliate in other ways. But a limited restriction, which we think seems more likely at this point, may be more symbolic than a meaningful hit to aggregate flows.
U.S. Travel Ban: Will Visitors Be Willing To Fly The Increasingly Unfriendly Skies?
As the Supreme Court prepares to take up President Donald Trump's ban on travelers from six Muslim-majority nations (albeit with a decision on the full legality of the ban unlikely this year), hanging in the balance are American businesses, including airlines, hotels, retailers, and others whose revenues are fueled by tourism.
Even without a decision, travelers may remain reluctant to visit the U.S. Marriott International CEO Arne Sorenson said in March that the previous month's bookings in the U.S. were down 10%-15% for customers from Mexico and 25%-30% for Middle Eastern visitors. In June, he said international travel to the U.S. was flat overall, but down 20% from the prior year for visitors from Mexico and the Middle East.
While the nations included in the travel ban provide only a small percentage of U.S. arrivals, the real issue is the broader implication and whether potential visitors will be put off by these restrictions and potential future constraints. One of our concerns is whether an increasing reluctance to allow travel to the U.S. may impact travel-related businesses. The damage to the bottom line could have a real-world impact as the jobs gains made by the restaurant and bar sector in July could be a thing of the past. Limited visitors to the U.S. combined with the disappointing report on personal income may hurt these industries and their economic contribution overall.
Immigration: Goodfellas, Or "Bad Hombres?"
President Trump has thrown his support behind a bill, sponsored by Republican Senators Tom Cotton of Arkansas and David Perdue of Georgia, that would cut legal immigration to the U.S. in half within a decade. The proposal would overhaul policy to favor immigrants based on their skills and education rather than familial relations.
From an economic standpoint, we agree that moving the needle toward an employment-based approach to immigration would likely increase the number of skilled working-age people in the U.S.--and this influx of young, skilled labor would spur economic growth, reduce the federal deficit, and help offset the deleterious effects of an aging American population. In 2014, S&P Global estimated that, if such sweeping change were to occur, it had the potential to add more than 3 percentage points to real GDP in the first decade (2015-2024) and more thereafter.
But at a time when the U.S. economy seems to be perennially stuck in a holding pattern around 2% annual growth, as the baby boomers retire, cutting immigration in half could put the U.S. on the path to even slower rates of economic growth. In addition, if the U.S. were to remove the roughly 7 million undocumented immigrants now working in the country, the federal government would lose almost $900 billion in revenue in a decade, according to a November 2016 study by economists Ryan Edwards and Francesc Ortega of Queens College. Moreover, given that undocumented workers hold approximately 5% of U.S. jobs and account for about 3% of private-sector GDP, the wholesale deportation of these people would lead to a cumulative economic loss of roughly $5 trillion in the same period (not including the costs of deportation), with agriculture, construction, and leisure and hospitality industries hit the hardest. On the flip side, the legalization of unauthorized immigrants would boost their contribution to GDP to 3.6% by expanding their job opportunities and spurring capital investment by employers.
As is the case with isolationist trade policies, we see protectionist immigration policies' detrimental effects in terms of revenues, economic contribution, and growth potential significantly outweighing the benefits for native workers seeking employment. However, convincing the electorate of the benefits of immigration will surely prove harder than simply pointing to an economic study, especially if their voting base believes otherwise.
How Soon Is Now?
As it stands, equity markets continue to bet that the current recovery has some legs, with the S&P 500 setting new highs on a fairly regular basis. But, as people become disappointed or increasingly worry, the knock-on effects of legislative inaction likely won't be pretty. Lost confidence means businesses don't invest and households don't spend--a troubling prospect, given that businesses' capital spending has been lackluster since the financial crisis and the fact that consumer spending accounts for 70% of the U.S.'s $18 trillion economy.
Meanwhile, the White House will be able to appoint (with Senate approval) at least three members to the Fed over the course of this year and next. Continued subdued wage gains in the jobs report following soft inflation data from the personal income report give the Fed reason to pause on raising rates this year after it announces its balance-sheet normalization plan in September, as we expect. But will a shift in the overall profile of policymakers affect the pace at which the central bank normalizes benchmark borrowing costs and reduces the size of its balance sheet? It's this type of uncertainty that can breed volatility in financial markets--though, clearly, that hasn't happened yet, with the closely watched CBOE Volatility Index (or VIX) recently dropping to an all-time intraday low.
Given the seriousness and complexity of the aforementioned issues, lawmakers have their work cut out for them for the remainder of the year and in the months leading up to the 2018 midterm elections. All 435 House seats will be up for grabs, and 10 Democratic Senate seats will be challenged in states where voters favored President Trump, potentially adding to the GOP's 52-48 edge.
Whatever the outcome, lawmakers have a rare opportunity to foster change that will bolster American business and the economy as a whole. Time will tell if they can find a way to do so. And whether they do will determine whether we see the economy continuing its sluggish pace or pulling out of the low 2% GDP doldrums it continues to languish in. At the moment, along with Congress, the jury's out.
Writer: Joe Maguire.