Donald Trump's New Republican Deal

Donald Trump's New Republican Deal
AP Photo/Scott Smith

June 2008 saw a tectonic shift in American politics away from the Republican Party to the Democratic Party, as voters signaled a preference for Barack Obama’s more redistributive policies. I concluded at the time that only when the Republican Party effectively acknowledged there was something wrong with their “product” and convincingly responded to the failures of today’s capitalist system would American voters reinstall the party to power. The election of Donald Trump and the Republican recapture of both chambers of Congress shows that the electorate has now been persuaded of a new Republican approach to the economy.    

The realities of the legislative process suggest the best chance to fulfill essential components of that plan is with a strong, bipartisan growth agenda in the coming months that abandons current partisan frameworks and seeks a “grand bargain” that marries smart infrastructure policy with smart tax reform.

Trump’s Promises to Voters

Candidate Trump vowed to mend the Republican brand by acknowledging: the need for improved monetary policy; a more aggressive reduction in taxes to spur job creation; new trade deals and immigration reforms to benefit American labor; more favorable regulatory frameworks for business; and a new way of thinking about American geopolitical alliances and pursuits. Furthermore, Trump’s promise not to weaken the social-safety net struck an important chord with voters, as the economy remains weak. Today, President Trump, with his executive authority, is well positioned to make good on a majority of these promises.

But it will be trickier for him to implement some. Specifically, his tax and infrastructure proposals must be passed through a legislative process that incorporates many political interests. Dangerous landmines exist here that, in many ways, will determine the economic outlook and the longevity of Republican power.

Conventional wisdom seems to be that Republicans will quickly pursue corporate tax reform via the budget reconciliation process and aim for an infrastructure spending deal with Democrats later in 2017. This would be a mistake.

Reconciliation rules dictate that any tax changes made through this process must be deficit neutral and expire within 10 years, which will reduce the beneficial effects of any tax cuts and the power of a near-term economic recovery. Furthermore, the weaker the economy is in the short term, the less cushion it will have to shield against unexpected, exogenous shocks — a legitimate concern given the strengthening dollar and likelihood of rising interest rates.

The anticipated legislative strategy would undermine Republicans’ stated priority of producing sustainable 3 to 4 percent economic growth and their electoral promise to produce “better capitalism.”

Capitalism, Socialism, and Democracy

Capitalism is a cold economic system, but, in the United States, it has been married to democracy, balancing profit motives with collective, social goals. Nations unmistakably benefit when the free market — the constant arbiter of returns on investment — is investing an abundance of capital, wisely. [1]

According to classical economic principles, an optimally functioning free market is rooted in sound currencies, low tax rates on capital, limited regulation, and geopolitical stability. The confluence of these factors optimize information signals and maximize rates of return. Of course, governmental policies can, often unwittingly, negatively impact these factors and thus decrease rates of return. Under these circumstances, the free market becomes suboptimal or even dysfunctional.

The late political economist Jude Wanniski reasoned:

“It is when a nation’s political system fails its economic system — when the market mechanism must refuse to finance unemployed resources because of a persistent negative ROI — that the masses have little choice but to turn to socialism. The body politic will permit the capitalist ruling class some reasonable margin for error, but it cannot permit either mass unemployment or a persistent decline in living standards that threaten the basic family unit.” [2]

These basic truths of political economy have inspired the Wanniskian maxim: When good capitalism goes bad, voters choose what they deem to be good socialism. In other words, in the eyes of the electorate, good capitalism is better than good socialism, but good socialism is better than bad capitalism.

We’ve certainly seen this maxim hold true during the last decade. Ten years ago, the Republicans stressed the virtues of the free market and shrinking the social safety net without any concrete policy action to protect the dollar and reduce tax rates on capital. Voters grew skeptical of this platform; they decided, in effect, that Republicans were not effective stewards of capitalism. So Americans opted for what the Democrats were offering: redistributive measures that included raising income taxes on the wealthiest, expanding governmental health-care provisions, and an increased social-safety net.

Fast-forward to 2016, Mr. Trump’s candidacy represented a new pact with voters that acknowledged previous Republican mistakes in overseeing the capitalist system while expressing a social awareness to support Americans harmed by the system’s dysfunction. Now, the work begins to implement this new Republican deal.

Breaking the Political Logjam

The political reality facing President Trump is that Republicans control only 52 seats in the Senate, eight short of avoiding a Democratic filibuster. This will prevent them from passing tax reform with a floor vote. Meanwhile, the conservative House Freedom Caucus is strongly opposed to increasing federal spending programs on “bridges to nowhere.” To some, the obvious strategy may be to pass tax reform through the reconciliation process, because it only requires a simple majority. Then, later in the year, Congress could hold a straight-up vote on increased infrastructure spending that would likely pass by capturing enough Democrats and moderate Republicans. While it may be the easiest legislative course, it will not produce the best policy outcome.  

But within this political logjam, there is tremendous opportunity for a more bipartisan approach that will produce a superior outcome.

Thus far, the House Freedom Caucus, which is worried about a replay in the growth of the federal government under President George W. Bush, has been outspoken in rejecting Trump’s proposal to spend $1 trillion unless it is substantially funded. At the same time, leading Democrats have pledged to thwart Republican plans to cut taxes on the highest income-earners. Congressman Richard Neal, Ranking Democrat on the House Ways and Means Committee, told Bloomberg in December: “There’s going to be opposition if these tax cuts are directed to the people at the top again.”

A political compromise that marries tax cuts on segments of the population with the most readily available risk-taking capital with a national infrastructure bank is the best option for each obstinate side of the stalemate.

For Freedom Caucus members who view economic growth as a priority, such growth cannot come from weak, temporary tax changes delivered by the budget reconciliation process. It must come from permanent tax cuts that win enough Democratic support in the Senate to earn at least 60 votes. What is more, worries about spending on “bridges to nowhere” would be alleviated by integral private sector involvement behind a national infrastructure bank.

For Democrats — whose stated policy objectives in the new Congress are greater infrastructure programs, child tax credits, paid maternity leave, and improved trade agreements — conceding to a more favorable tax code would quickly accomplish one of their top priorities. Additionally, their efforts would introduce the first major trial of a productive, 21st century public-private partnership.

This is the kind of political compromise that would demand President Trump’s leadership. And, perhaps, it is exactly what the electorate anticipated in the voting booths in November. Trump clearly campaigned to pursue attractive tax rates for companies to reinvest and increase employment as well as to rebuild the country’s infrastructure. But it is likely that the electorate was also inspired by the image Mr. Trump portrays: the ultimate dealmaker, prepared to work with both sides of the aisle to strike the best possible deal to restore the power of capitalism while at the same time protecting social safeguards already established by a distraught, yet hopeful people.

Paul Hoffmeister is a partner and portfolio manager at Quaker Funds, and economic counsel at Bretton Woods Research.

[1] Jude Wanniski, “An Essay on Economic Growth,” The Brown Economic Review (Spring 1999), pp. 7–10.

[2] Ibid.

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