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Trump first, not America?

02 November 2018

Donald Trump's quick-fire decisions on tax and finances could impact the US economy for years to come, argues Guy Stephens of Rowan Dartington.

The investment environment appeared much darker last week, whether due to Brexit plans in the UK, Italy’s relations with the EU, or Donald Trump's usual variety of weekly threats – last week’s threats included sanctions on Saudi Arabia, extracting the US from Russian nuclear deals, and placing more tariffs on China.

Last month, it was just this kind of news that overwhelmed the bulls, leading to a sell-off. Yet at some point investors tend to decide that ‘enough is enough’, and the buyers come back. Add in some decent quarterly results, and the bulls start to believe there are bargains to be had. Such is human psychology, otherwise known as the madness of crowds.

The US mid-term elections are meanwhile creeping up on 6 November and causing a frenzy of speculation in the US. We cannot recall a time historically when so many non-US citizens have been so focused on the outcome. It is quite possible Trump will lose the House of Representatives – the lower house – to the Democrats, while the Senate is probably secure.

The mere fact the US economy appears to continue to cook on gas is reassuring, as it is the primary prop to world growth and stable markets.

But Trump is certainly kicking the foundation pillars with his tariffs and tax cuts, potentially fuelling inflation with both. It comes as some relief, then, that the US Federal Reserve is not flinching from the president's criticism, which has been universally condemned by global financial heads. But then Trump must line someone up as the fall guy when his economic miracle starts to lose its lustre.

Any administration in the world, if it has the firepower, can cut taxes, hike spending and win voter support as GDP temporarily surges. It is in the aftermath of a burgeoning budget deficit, when tax receipts have plummeted, that the chickens come home to roost, as a period of austerity is required to fill the financial black hole.

Trump believes in the Laffer Curve. This was developed by Arthur Laffer in 1974 and is based on the premise that, as taxes rise, less revenue is generated over time, because entrepreneurial risk is stifled. Of course, that depends on what is being taxed and on the elasticity (or change) in demand as taxes rise. This is why, in the UK, where so many of us have to drive, we all suffer from heavy tax on car fuel.

But Income Tax is an entirely different matter as, if very high taxes are introduced on high earners, they will seek out ways to avoid it; with the result that the tax take actually falls.

We have seen this recently with Capital Gains Tax rules, whereby the rate payable has fallen significantly from the marginal rate of income tax to one of two much lower rates. Consequently, individuals are more likely to pay it and the tax take actually rises. For the Treasury, 20% of something is better than 40% of nothing.

In the land of Trump, however, he believes cutting corporation tax from 35% to 21% may reduce corporation tax receipts by 40% - a huge number – but that the reduction will ultimately be offset by higher receipts, as the lower rate of 21% will be calculated on the basis of a much faster-growing – and therefore bigger – economy.

In reality, for that to occur, ignoring other tax cuts and spending commitments, the US corporate economy would have to grow by two-thirds to realise the same tax receipts. Spread that over 10 years and you would need an economic uplift of over 5% a year to recoup it. It also assumes companies reinvest the benefit of the tax cut into their business, enhancing employment and productivity.

Besides, while there has been some job creation, the US is at full employment, and many companies are actually using the windfall to buy back even more of their shares from the equity market. So long as corporate coffers are swelling, you shouldn’t expect this US market sell-off to last for that long.

Bigger worry

The bigger worry is what happens in Congress when Trump leaves the White House – whether that’s in two years or six. Neither period is long enough for us to fully appreciate whether the dramatic tax cuts have moved the US onto the optimum point of the so-called Laffer curve; which is when stronger growth delivers the best possible combination of tax rates and tax take.

For now, the US economy is receiving a massive shot in the arm, the voter is enjoying a boost to take home pay, and growth is peaking at 4% a year, with inflation subdued and interest rates normalising towards 3.5%. It looks like the holy grail of capitalist economics. If the Laffer assumptions above are borne out, however, the US budget deficit is going to balloon and the next administration is going to have to sort out the mess.

The US is very much living for today – and its president may merely be eyeing the next election. His slogan should be ‘Trump First' rather than ‘America First', because the current economic fruits of largesse cannot possibly last.

Traditionally, UK governments on the right tend to cut taxes and spending, and those on the left to increase taxes and spending. Trump is cutting taxes and increasing spending - surely a recipe for trouble for tomorrow.


The levels and bases of taxation, and relief from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

Rowan Dartington is the discretionary fund management and stockbroking arm of St. James’s Place. Guy Stephens is technical investment director at Rowan Dartington. All views are his own and should not be taken as investment advice.

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.


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