The First Trump Budget (Such As It Is)

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by: Lance Brofman

Summary

The Trump Administration Budget Does Not Include Revenue, Mandatory Spending or Deficit numbers.

The Trump Administration Budget essentially reallocates $54 billion from non-defense discretionary spending to Defense spending.

The Republican replacement for Obamacare involves large tax cuts for high-income taxpayers and increases the number of people uninsured by 24 million.

High-income taxpayers would save more and spend less of the extra income they receive, as compared to the lower income people who will lose health care subsidies.

The Republican replacement for Obamacare would reduce aggregate consumption and thus GDP by shifting money from those with high a propensity to consume to those with a lower propensity.

The Trump Administration and the Republican congress have made its first foray into the arcane world of budgeting and forecasting. These exercises are usually reserved for the economic advisory teams. But the new administration's economic team is bare boned to say the least (a Council of Economic Advisors is not yet in place), and the amount of detail in its budget document is bare boned as well.

The Office of Management and Budget (OMB) presented a 52 page "Budget Blueprint to Make America Great Again". It stands in sharp contrast to the budget documents of previous administrations. Those detailed budget requests for spending; they detailed revenue estimates based projected tax policy and the economy's performance; and they would show outcomes for the current year and ten years into the future.

Trump's OMB document only covers the 2017-2018 period. It does not incorporate an economic forecast nor does it include any projections of revenue and spending on various non-discretionary entitlement programs. It only addresses discretionary spending levels as specified by the Budget Control Act of 2012 (BCA). BCA indicates the levels of non-defense and defense discretionary spending permitted under sequester rules.

From our previous budget analyses, you may recall that expenditures for overseas contingency operations are considered non-discretionary. Therefore, these have never been included in sequester. These expenditures will most likely rise from levels of the past several years and from levels that had been projected for the future by the Obama Administration.

Taking the Trump OMB data at face value, it can be said that this would be a first raw attempt to reallocate federal government budget priorities away from an emphasis on the social welfare and toward defense and national security. Its priorities are a violation of the BCA which stipulates dollar for dollar changes in non-defense discretionary outlays and defense discretionary outlays. The budget requests outright reductions in non-defense discretionary programs and increases in defense spending over and above levels proscribed under the sequester order.

For 2017 the current law budget cap for sequester programs is set at $1.070 trillion, comprising $551 billion for defense and $519 billion for non-defense. This total excludes cap adjustments made in the bi-partisan Budget Act of 2015 which allowed for a two-year supplemental above the sequester caps. For 2018 budget caps stipulate $1.065 trillion in total of which $549 billion is for defense and $462 billion is for non-defense.

These budget priorities have already been declared dead on arrival by many members of congress and by the news media. But this may be somewhat premature. On the non-defense side a budget axe falls on almost every agency including the EPA, the Agriculture Department, the National Institutes of Health, and even the State Department. Most everyone admits programs sponsored by these and other agencies and departments are archaic, duplicative, and riddled with waste. Trump is making a first effort to trim this fat.

Indeed, embedded in the administration's request is moving funds from various departments to control by the White House. The argument is that this would result in a much greater bang per buck; projects would be completed on time; and they would most likely be completed under budget.

Interestingly many programs that would be cut fall under the umbrella of infrastructure. The Trump Administration has been advocating for a ten year $1 trillion infrastructure program. An opposing argument is that such a program would be a budget buster. However, by shifting funds from agencies and departments to the White House, it would neutralize the budgetary impact; allow the Trump team to claim fulfillment of a campaign promise; and ideally be effective in improving the nation's infrastructure.

On the defense side the administration has at least one important advocate albeit one with strained relations to the White House. Senator John McCain chairs the Senate Armed Services Committee and is a supporter of a 5 year $250 billion increase for the military over and above the budget caps. Meanwhile, defense spending has a higher multiplier effect on the economy than non-defense and therefore would provide more economic stimulus. Further, periods of rising defense spending both absolutely and relative to the size of the economy have been associated with periods of rising productivity growth.

The Trump team will argue that its reordering of priorities will be positive for economic growth and thus help reduce the structural deficit. Needless to say, there will be acrimonious debate over violating the budget caps and reordering priorities especially since opponents can point to a steady decline in the deficit since the BCA's enactment. In the end cynics might be quick to conclude that legislators and the administration may find it more palatable to bust the budget caps and boost both defense and non-defense discretionary spending above sequester levels.

But this would resurrect the issue on the likely damaging effect on the overall deficit. And with former House Freedom caucus budget hawk Mulvaney now serving as OMB director, it is doubtful the administration will be very malleable. It should be a very interesting negotiating process.

Longer term budget projections will be impacted by the House republicans' American Health Care Act (AHCA) which would replace the Affordable Care Act (ACA). Since AHCA is still a work in progress this could be construed as a rationale for the current OMB's failure to offer longer term budget projections.

Nonetheless, the Congressional Budget Office (CBO) has scored the initial version of the AHCA. CBO does not attempt to incorporate macroeconomic effects, however, which is a violation of rules imposed by the House of Representatives. In CBO's defense the current version of the AHCA will be amended in Senate - House negotiations and further amended by rules changes likely to be unilaterally undertaken by the Health and Human Services department secretary Tom Price.

There are some macroeconomic principles that may be applied to the AHCA however. The balanced budget multiplier concept is a well known and widely accepted economic tenet. It is that an increase in government spending matched by an increase in taxes results in a net increase in GDP by the same amount. Likewise, a decrease in spending matched by a decrease in taxes results in a net decrease in GDP by the same amount.

By this formulation then, a decrease in government spending combined with a smaller decrease in taxes results in a net decrease in GDP by a greater amount. CBO concludes that over the 2017-2026 period federal outlays to finance AHCA would be reduced by $1.2 trillion versus ACA while revenues would be reduced by $900 billion. Thus, the cumulative deficit would be reduced by $300 billion. This is important because this allows the AHCA to be enacted under reconciliation rules which only require 51 votes in the senate. Were AHCA to be scored as increasing the deficit 60 votes would be required to overcome a senate filibuster.

CBO's analysis concluded there would be 24 million more uninsured than under the ACA. It should be noted that CBO does not have a good record on this matter. It initially estimated that 24 million would be added to the insurance roles under ACA when in fact the number was only 10 million. This aside, it is critical for the success of the bill that the estimate of insured individuals be close to 24 million. If CBO concluded there would be fewer, the deficit projection of a $300 billion saving would be lower because more people would receive subsidies. This will be an increasingly important consideration for the bill's sponsors as the initial AHCA plan is amended to satisfy various constituent groups including the White House.

Beyond this it is important to note that the Balance Budget multiplier concept assumes there is one marginal propensity to consume for both those who receive government outlays and those whose tax liability is changed. The bulk of the tax cuts in the AHCA are from repealing the surtax on certain high income taxpayers' net investment income, and from repealing the increase in the Medicare payroll tax rate for certain high income taxpayers. To be sure some would argue that eliminating these taxes would actually increase revenue by boosting the incentive for realizing capital gains. This may be valid in the aggregate, but it seems like a shaky argument in this context

This aside, high income recipients certainly have a lower marginal propensity to consume than the general population. So, high income taxpayers would tend to serve a much higher percentage of any extra disposable income. Lower income individuals, who will receive lower subsidies and thus pay a higher insurance premium, will likely reduce their total spending as opposed to reducing savings; unless that is, they simply opt not to buy insurance.

Another possible consequence of AHCA could be that many employers will opt to end employer sponsored health plans. In addition to the obvious savings by employers by not providing health insurance, employers could have an easier time attracting low wage workers by offering a marginally higher wage that would boost take home pay.

Thus, from a macro perspective AHCA would have a deflationary effect on the economy. It is clear that the ACA is flawed in terms of financing and coverage in a cost-effective manner. Because various financing mechanisms have been weakened or discarded - for example the Cadillac tax, the medical device tax, and the individual and employer mandate - the financial burden of the law will be much higher than previous and current CBO estimates. Meanwhile, weakened penalties under the mandate provide a disincentive for young, healthy individuals to obtain coverage, leaving the insured pool heavily skewed toward the ill and elderly, resulting in the so-called death spiral.

It is unclear whether the AHCA will effectively address these shortcomings. To be sure CBO suggests budget savings will be realized but at the expense of a smaller number of insured. To us the macro considerations are even more important. If spending patterns are altered such that aggregate demand is reduced, slower economic growth will result, thus neutralizing the direct savings and perhaps even exceeding them., thus worsening the overall fiscal outlook.

In short, there is no such thing as a free lunch. The AHCA may offer greater choice and individual responsibility, the cure could be worse than the disease for the economy.

This article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by Beach Investment Counsel, Inc. and is used with the permission of both.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by Beach Investment Counsel, Inc. and is used with the permission of both.