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In a few years, we may look back at the events of last week and debate how the bombing of a Syrian air force base by the executive branch and the exercise of the nuclear option by the U.S. Senate changed the course of the Trump administration and, quite possibly, the global economy. Viewed in isolation, each of the two events could prove to be consequential. Yet the most interesting aspect is the potential effects that the interaction between these two policy actions may generate.

The Trump Administration

In the aftermath of the bombing of the Syrian air base, many in the press were pointing to his previous tweets and comments during the campaign regarding Syria and U.S. involvement in the region. Based on these tweets, one would not have forecast that the president would be taking such a course of action. While some view this as a contradiction, we believe that the events reveal much about President Trump’s personality and decision making process.

As he has said so many times, President Trump is flexible and willing to change his mind. In this instance, he also showed that he is not dogmatic or an ideologue as some of his predecessors (Presidents Barack Obama, George W. Bush, and Ronald Reagan) were. He also showed that he was decisive, willing to act, and that it does not take very long for him to reach a decision. More importantly, he did not tip his hand. He had dinner with China’s President Xi Jinping while the bombing was underway, as if nothing was going on and did not inform Mr. Xi until after the bombing was completed. In our opinion, all of this is quite favorable to President Trump. Add to all this that he asked his advisors for a plan, he appears to have listened, chose the option he thought was best, and gave the order.

The bombing indicates that President Trump is not necessarily beholden to previous statements. This suggests that it will be difficult to forecast President Trump’s action on foreign policy or economic policy. For those who invest money, the disclaimer on managers’ track record may be applicable here: past performance is not necessarily an indicator of future performance. In that sense, the commentary that Mr. Trump will be a high variance president may be appropriate. But as we mentioned in one of our earlier publications, in a mean variance world, the volatility or variance is only part of the story. The mean is the other part. Clearly in a mean variance context, a higher variance and lower mean is not a good combination. But a higher variance and higher mean may be. Did the bombing of the Syrian Air force base provide us with additional information about the potential mean and variances of the Trump administration? So far, the argument presented suggests that the events in the context of the previous tweets indicate a higher variance. But what about the mean? And did the Senate’s actions alter the potential mean variance relationship? If so, in which way?

The incident shows that he can make decisions, something we already knew. It also shows that he is willing to choose options provided to him by his advisors and that he personally can execute his part of the plan. Those are all good things. If this is correct, the success of his policies depends greatly on the quality of the policy options developed by his staff and advisors. If the plans offered by his advisors are sound and detailed, his administration should be able to execute it, whether it is national security, tax reform, or some other policy initiative or campaign promise. During the campaign for the presidency, Mr. Trump showed great instincts and understood better than the other candidates where the electorate was and where they wanted to go. That is a true gift. But as the administration is learning, instincts alone are not enough. The executive branch needs organization and a way to execute its program. As the saying goes, the devil is in the details. This is something that seems to have derailed some of the earlier efforts of the administration. The travel ban and health care reform are two examples. The leaks and recent resignations are a couple of other examples of potential disorganization and disarray. But these problems of inexperience in governance are easily solved when people with experience in government bureaucracy are appointed to help the new administration navigate the government maze.

In large part, we attribute the turmoil within the Trump administration to the lack of government experience. President Trump promised to drain the swamp and part of his strategy was to bring people outside the government. Unfortunately, these people did not know where the “bodies were buried” and have had to learn on the job. That leads to missteps and the administration is paying a high political price as the implementation of its programs either gets delayed or derailed. This is not an uncommon mistake that political leaders make. In the extreme version, we have the case of Iraq after the fall of Saddam Hussein, where the military and all the people who were party members were fired. What Mr. Rumsfeld failed to consider was that in a dictatorship and in many other parts of the world, the most common way to get a civil service job is to become a member of the ruling party, even if one is not political. In any event, the policy of firing the Ba’athist civil servants and military led to administrative chaos and a descent into lawlessness. Someone has to keep the trains running and the Ba’athist were the ones who knew. Fortunately, in the U.S. the institutional structure and the strength of its democracy are deeply ingrained and we don’t foresee a descent into chaos. However, the administration needs to hire people who know how to make the trains run on time, irrespective of party affiliation. Otherwise it will not be able to implement its agenda and will fail to drain the swamp and make America Great Again. The Trump administration will continue paying a heavy price while facing a steep governance and legislative learning curve.

The Senate and Filibusters

The recent Senate battle regarding the confirmation of Judge Neil Gorsuch to the Supreme Court is another major event that could have a large effect on policies well beyond the Trump administration. We are not going to debate the history of the events that led the Senate Majority Leader to invoke the “nuclear option.” One obvious and immediate effect is the appointment of Judge Gorsuch who, given his age, is expected to have a long service with the court. On the judicial side, the nuclear option may also potentially impact the timing of the retirement decision of some existing Supreme Court judges.

On the legislative side, there are some other interesting dynamics. One issue that immediately comes to mind is whether the nuclear option is going to be invoked for other legislative issues. The fact that the Republicans already used it makes it more likely they could use it again. How will that affect the Democrats in Congress? Will they be more willing to negotiate or are they going to vote as a block and lose, and then hope that two years from now they can retake either the House or the Senate. Will there be more policy volatility?

If the filibuster is completely eliminated, then the voters will also have a lower threshold to change the make-up of the legislature. However, the changes will not be as drastic and as often as one may be led to believe. Congress has some protection against the voters’ rage and it’s called gerrymandering. It is an option not afforded to the Senate. The state lines are already drawn and there is nothing the senators can do to change the boundaries. Their defense is the 6 year term and that only one third of the Senate is up for election every two years. While these are obstacles to a drastic change in the House and Senate, the lowering of the threshold from filibuster to simple majority increases the voters’ ability to alter and influence the makeup of Congress and the Senate. A smaller number of seats are now required to affect a change in the composition and legislative effectiveness. Finally, if the legislators enact laws that the voters demand, there will be no need to replace them. In this case, the volatility will decline, and this would be a good thing. Policy volatility will only increase if the voters and legislators are not in sync, in which case the turnover in the legislature will also increase.

The Interaction between the Administration and the Legislature: What Could be?

Abandoning the filibuster on the budget issue could greatly simplify the Trump legislative agenda. For example, if there was no filibuster issue, there would not have been any need for a three-part repeal and replace of Obamacare. There would not have been any need for a reconciliation process. A cleaner bill would have been proposed and the whole process would have been much easier and perhaps even successful. This is something that should not be overlooked in terms of both ACA and tax reform. A potential elimination of the filibuster reduces the power of the minority. It makes it less likely that the Trump administration would have to negotiate with the Democrats at the expense of Republican legislators. Given their majority status, the lower threshold to pass a legislation means they need less Republicans to pass a bill and even less Democrats. Only true bipartisanship would require both parties. Also, the math suggests that President Trump will have a tougher time governing solely with the Democrats at the expense of conservative Republicans in Congress. Also there is a little thing called elections every two years. The removal of a filibuster will increase the legislators’ accountability to the voters.

Tax Reform

A final point in the discussion has to do with one of President Trump’s campaign promises: tax reform. He promised a big tax cut during the campaign. But as we have already seen, while he is big on keeping his campaign promises, he is not that focused on the details. A good tax reform to one is not necessarily a good tax reform to others. Then there is the issue of the process and how to go about it.

Reports in the press are now mentioning that the White House is going to take the lead on the tax reform legislation. That raises a number of issues to us, none of which are good. The first issue has to do with the process. Shouldn’t the legislation originate in the House? A second issue is that during the campaign President Trump had a plan and he appears to be backing away from the plan for reasons that we will discuss in a bit. But our main concern here is that if they start from scratch, they will be rushing and perhaps not craft a coherent and well thought out plan. Another concern is that his economic team working in the White House consists mostly of bankers, not economists or policymakers. It is very difficult to get something right the first time out.

Other potential problems with the tax reform has to do with the constraints that the political process and the filibuster rules are imposing on the administration and legislature budget process. One requirement that is being imposed is that the tax reform be revenue neutral. This requirement will immediately lose the Keynesians. For if the reform is revenue neutral, there will be no net income effect. Government spending does not change and one group’s gain is another group’s loss. There is no net change in aggregate demand, only income redistribution.

Supply-siders focus on the marginal tax rates and, as such, they will focus on the nature of the reform. They will argue that the larger the reduction in the top rate, the better. The lower the reduction in the top rate, the greater the income redistribution and the smaller the incentive effects. The supply-siders will also argue that the revenue neutrality imposes an unnecessary constraint that limits the potential reduction in the top marginal tax rate. While one may argue that this is a very nuanced argument, it is very apparent that there are many possibilities that produce revenue neutrality without significantly impacting the marginal tax rate. That would be a great mistake and a lost opportunity. One reason to be concerned about this possibility is the other possible constraint being imposed on the tax reform. The original campaign promise for reform is now being abandoned. One common reason given is that half of the benefits of the reform accrue to the top 1%. Presumably the new proposal would be designed that no benefit goes to the top 1%. But how are they going to accomplish this?

In order to illustrate the potential pitfall of the new tax reform design that is being talked about in the press, let’s review some data. Currently the top 5% pays about 60% of the taxes, while the bottom 50% pays less than 3%. Taking these numbers at face value and using a simple static analysis, it is easy to see that any reduction in the tax rate structure that is proportional will yield the bulk of the benefits to those who pay the bulk of the taxes. Hence in that sense saying that the top 1% gets most of the benefits is equivalent to saying that the top 1% pays the bulk of the taxes which we know is true. On a static basis, such a tax reform will never help the lower income people. The only argument for such a reform is that the reduction in tax rates will expand the economic pie and make every one better off. That is, a dynamic analysis is needed in order to justify the tax rate cut otherwise it does not make any sense from a growth perspective. But that is not the only rationale for the reform. Preventing the top 1%, those who pay the most taxes, from getting their share means that the reform is nothing more than an income redistribution scheme disguised as tax reform. The final question is how the reform is going to help lower income people if they pay no taxes. Is the tax reform going to increase the refundable credits for lower income families?

If the Trump administration’s objective is to deliver the growth rate that he promised during the campaign, the reduction in tax rates is the way to achieve that growth. The more the reform deviates from the lower tax rate principle, the smaller the impact incentives and the smaller the dynamic effects will be. The Trump administration’s guiding light should be focused on reducing marginal tax rates, as any deviation from the rate reduction is not growth-oriented. Also, where the law originates matters to its success. President Trump should let Congress take the lead on this.

About the Author

Victor A. Canto, Ph.D.
Chief Economist




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