Supply-side economics likely to dominate Trump’s economic agenda

Donald Trump’s vision of economics is becoming clear as he makes his cabinet picks. In particular, his picks of Steven Mnuchin as Treasury Secretary and Larry Kudlow as probable Chairman of the Council of Economic Advisors point to a more traditional Republican bent, which makes it less likely his policies will meaningfully reduce the income inequality which I believe was behind his surprise victory. Gary Cohn as NEC head is a bit of a wild card. Most likely, Trump will go for some variant of supply side economics, concentrating on lowering and simplifying taxes and making bilateral trade deals.

Kudlow is a key figure here because he has been so public for such a long time. He is a big supporter of supply-side economics, which is a view of the economy where economic growth is fastest as a result of increased capital formation and lower barriers on trade. Under supply-side, business investment is critical, making most supply-siders huge proponents of lower business taxes and less regulation.

Mnuchin is also a supply-sider. While he has said that he wants the Trump Administration to “make sure that the average American has wage increases and good jobs” he indicated “our number one priority is tax reform” to achieve that goal. Mnuchin has said he wants to reduce corporate taxes to 15%. He has also said he wants to reduce taxes for the middle class, and simplify the tax code. On trade, he has said he does not support big regional trade blocs. Rather, he supports bilateral deals. In my view, this makes a Trump Administration likely to pursue a UK trade deal.

If you look back on the history of supply-side as practiced – as opposed to as developed in theory – there is a considerable amount of horse trading you should expect to see, in order to get policy through. The experience of Kudlow as the number two under David Stockman in 1981 at the Office of Management and Budget is instructive of what is likely to happen. Here are a few snippets from a December 1981 article of The Atlantic magazine called “The Education of David Stockman”:

“The hard part of the supply-side tax cut is dropping the top rate from 70 to 50 percent—the rest of it is a secondary matter,” Stockman explained. “The original argument was that the top bracket was too high, and that’s having the most devastating effect on the economy. Then, the general argument was that, in order to make this palatable as a political matter, you had to bring down all the brackets. But, I mean, Kemp-Roth was always a Trojan horse to bring down the top rate.”

A Trojan horse? This seemed a cynical concession for Stockman to make in private conversation while the Reagan Administration was still selling the supply-side doctrine to Congress. Yet he was conceding what the liberal Keynesian critics had argued from the outset—the supply-side theory was not a new economic theory at all but only new language and argument to conceal a hoary old Republican doctrine: give the tax cuts to the top brackets, the wealthiest individuals and largest enterprises, and let the good effects “trickle down” through the economy to reach everyone else. Yes, Stockman conceded, when one stripped away the new rhetoric emphasizing across-the-board cuts, the supply-side theory was really new clothes for the unpopular doctrine of the old Republican orthodoxy. “It’s kind of hard to sell ‘trickle down,'” he explained, “so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.”

But the young budget director once again misjudged the political context. The scaled-down version of the administration’s tax bill would need to carry a few “ornaments” in order to win—a special bail-out to help the troubled savings-and-loan industry, elimination of the so-called marriage penalty—but he was confident that the Reagan majority would hold and he could save $70 billion against those out-year deficits. The business lobbyists would object, he conceded, when they saw the new Republican version of depreciation allowances, but the key congressmen were “on board,” and the package would hold.

In early June, it fell apart. The tax lobbyists of Washington, when they saw the outlines of the Reagan tax bill, mobilized the business community, the influential economic sectors from oil to real estate. In a matter of days, they created the political environment in which they flourish best—a bidding war between the two parties. First the Democrats revealed that their tax bill would be more generous than Reagan’s in its depreciation rules. Despite Stockman’s self-confidence, the White House quickly retreated—scrapped its revised and leaner proposal, and began matching the Democrats, billion for billion, in tax concessions. The final tax legislation would yield, in total, an astounding revenue loss for the federal government of $750 billion over the next five years.

I would point out a few things here. First, notice Stockman’s characterization of supply-side as tickle-down economics. He’s basically saying that income and wealth accrue first to business owners under supply-side. And only when they invest in capital and create jobs does that income and wealth “trickle down” to everyone else. This is a standard Republican economic position. There is nothing radical or populist about it whatsoever.

Second, you can see how the sausage gets made here; special interests inserted themselves into the process and extracted benefits. We should expect the same thing to happen when the Trump Administration tries to reduce taxes and simplify the tax code. Business lobbyists will be all over Trump’s people. And they will win concessions.

Now Mnuchin says he is all in for personal income tax reductions as well. Judging from what I have heard from the likes of Mitch McConnell regarding deficits, it is going to be very difficult to get meaningful tax reduction through Congress, despite the fact that Trump’s own party is in control.And when push comes to shove, Trump may give up on personal tax reductions to get what he wants elsewhere in his program as the other features — tax simplification and business tax deduction — are an easier sell to Republicans in Congress. Trump is also talking about getting rid of the estate tax, by the way. But that only helps the rich, since the exemption now is $5.45 million for individuals and $10.9 million for married couples.

I don’t know where Gary Cohn is on all of this. He is a registered Democrat. But given his bilateral political donation history, he’s likely a centrist.I don’t see him as someone who will block the supply-side agenda of Kudlow and Mnuchin.

Two other points here. If you look at the people that Trump has selected beyond his economic team, it’s clear that he is looking to reduce regulation. All of his appointments are anti-regulatory people. Some, like Rick Perry, even wanted to eliminate the very agency they are now leading. So the supply-side mantra of less regulation, helping business – especially small business, because they don’t have armies of lawyers and accountants – is evident everywhere in the Trump Administration. And this ideological bent makes sense given his background in real estate.

The Mnuchin comments on bilateral trade deals are interesting too because it makes me think first and foremost about Brexit. The potential for the UK to pivot to an Anglo-American trading nexus, with Canada, Australia, and New Zealand also present, increases if the Trump Administration is actively engaging Liam Fox and David Davis. I would expect there to be overtures around bilateral trade as soon as Trump gets in, if not before, given the Obama Administration’s cool stance toward a potential UK deal.

Overall though, I see Trump as having been elected due to voters angry about declining income growth and job security, particularly in the rust belt states that had voted for Obama in 2008 and 2012. That means Trump needs to appeal to this group in some discernible way to be successful. He even said so himself on election night, talking of having only two years to make his mark. He might be able to appeal to them on cultural grounds the way Republicans have done in the past. I don’t see that being effective though given the angst still evident after seven years of recovery. But supply side isn’t going to do it either unless Trump can create enough growth that it reaches deep into the rust belt where all the manufacturing jobs have been lost. His interventions against individual companies like Carrier can only go so far. At the end of the day, he has to deliver jobs and income.