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Tax Reform: The Impact On Macro Fiscal Flows And Investment Markets

by: Alan Longbon

The Senate and House have passed the tax reforms, they are going to happen and this can be traded.

Macro fiscal flows from the government sector will now increase and grow GDP.

Investment markets generally will have some more fiscal space within which to rise.

This article will show how the recently passed federal tax reforms will impact macro fiscal flows and investment markets.

To assess the impact of the tax reforms a stock flow consistent sectoral flow model will be used.

Stock Flow Consistent Sectoral Flow Analysis

British economist Professor Wynne Godley developed Sectoral flow analysis and accurately predicted all our recessions since 1970.

Growth inflows come from three broad sources:

1. Private credit creation. [P] - Banks lend more than is repaid. (credit money)

2. Government spending. [G] - The government spends more than it taxes. (state money)

3. Externally from overseas trade and commerce. [X] - Exports earn more than exports cost, less capital flows. (credit money and state money from other countries)

GDP = P + G + X

This is an accounting identity and correct by definition.

The following chart shows the interplay of the three sectors over time:

From the chart, one sees that the government flows mirror the flows of the private sector and external sector with the symmetry of butterfly wings. Note how government budget surpluses and/or low-deficit spending proceeds a recession. One sector's loss is the other's gain and vice versa.

The government deficit is the private sector's surplus and vice versa.

If we add the sector flows, we can work out how much money is flowing to the private sector and how much the GDP growth rate is. If the result is positive, then financial assets in the private sector, such as stocks and bonds, can be expected to rise in value.

Each flow will be examined in turn as we assess each income channel to the private sector.

Private Credit Creation

Credit creation in 2016 was quite high averaging over 5% for the year and made a contribution of 0.7% to GDP.

For 2017, the story is different. Credit creation has added only $20B to the economy so far this year and this represents only 0.11% of GDP.

The chart below shows how the stock of total private debt from credit creation is building for both the household and corporate sectors:

(Source: Professor Steve Keen)

Household debt as a total percentage of net disposable income, 2015 (OECD), is 111.6%.

The mainstream neoliberal economic model depends on the money supply being provided at interest by private banks and not by the government via state money.

When the private banks are not able to expand the money supply through lending then GDP growth stops. The money supply is constrained by the number of credit worthy borrowers ready, willing and able to take out a loan.

Loans create deposits and generate the required reserves at the Fed. Repayment of loans reverses this process and shrinks the money supply and is deflationary.

External Sector

The external sector is trade and commerce with other countries and is shown in the current account. The current account is exports less imports, and it also includes capital flows in and out of the country from financial transactions and investments.

The chart below shows the current account balance. The chart shows the current account is both negative and therefore a leakage of dollars from the economy of -2.6% of GDP each year. This year is tracking to be a bigger deficit than last year and could easily be -3% of GDP.

A large current account deficit is deflationary because it drains the economy of money in return for goods and services from overseas.

Federal taxation is also deflationary as it removes money from the economy. More on this later.

The role of federal taxation in a monetary sovereign country like America is to control inflation by removing spending power, which then reduces aggregate demand.

The external sector can perform the same fiscal deflationary role but with the benefit of goods and services from overseas.

What would one rather have?

  1. Imports of real goods and services for dollar credits, meaning lower inflation, lower taxes and lower unemployment; or
  2. Exports of real goods and services, meaning higher inflation, higher taxes and higher unemployment.

Clearly the former is the wiser choice and the one we have.

Government Sector

The government budget is shown in the chart below:

The government spent approximately 3.2% of GDP into the private sector in 2016.

The near term government budget is shown in the chart below to the month of October 2017. At present, budget expenditure looks to be tracking to be less than for 2016 and one could posit that the total expenditure could well be less than 3.2% of GDP in 2017. At the very least the next budget result will be very similar.

The Trump government's tax reform means that less will be taxed out of the economy. An analysis of the impact of the tax reform shows that most agree that taxation reductions will add one trillion dollars to the private sector over ten years.In the American system one billion is 1,000,000,000 and a trillion is 1,000,000,000,000 so one trillion is one thousand times one billion.

So each year the government will add an additional $100 billion to the private sector by virtue of not removing it via taxation. $100B is approximately 0.54% of GDP and would move the federal government contribution to total GDP from 3.2% to 3.74%, based on the 2016 result shown in the chart above.

At present America has an unemployment rate of 4.1% though one could argue this is much higher given the lower participation rate. The chart below shows this impact. The real unemployment rate could well be 8%, plus the level of underemployment, which as a rule of thumb allows one to double the figure again to 16%.

(Source: Professor Phillip Soos)

The capacity utilization rate is 77% meaning that 23% of Americas land, plant and equipment is idle.

One could make out an argument that the government could employ this idle labor and capacity that the private sector has no use for and put it to work for the public purpose.

The prevailing neoliberal model leaves credit creation and allocation to the private banking sector on the assumption that the free market does this most efficiently and that free markets are perfect. Government is encouraged to be small and not interfere with the operation of the free market.

Game theory suggests that financial predators will eat all prey until none is left and then die from starvation.

The sector flows at present and for some key historic points of reference are shown in the table below:

Private Sector Credit Creation


External Sector


Government Sector






-2.6 %



2017 Now

0.11 %




2018 with tax reform





2009 post GFC Trough

1.04 %

-2.7 %

9.8 %

8.14 %

2007 pre GFC Peak

1.17 %

-5.1 %

1.1 %

-2.83 %

1943 War economy

NA -0.9%



2000 pre-Dot Com Boom peak

3.9% -4.05%



2001 Dot Com Bust, peak flows

3.2% -3.74

3.37% 2.83%

(Source: Trading Economics, FRED and Author calculations based on same)

In 1943 as America was gearing up for the 1944 Normandy invasion, no one asked "how are you going to pay for that". Tanks, battleships and bombers were built using state money; there was full employment and no inflation. Imagine if the same productive power was put to peacetime usage on education, health and infrastructure.

How can one trade this decision?

There is now a trade-able financial decision point that one can use. From a macro fiscal flow perspective the decision is good news for the economy and gives financial assets in the private sector fiscal space within which to grow in value. Financial assets such as stocks, bonds and real-estate can be expected to rise in value. This is the important takeaway.

A more detailed analysis of sub-sectors within the private sector can determined those that will benefit more than others.

What tends to happen is that when the government stimulates the economy with fiscal spending, the other sectors improve as well. This is due to lower costs of living and doing business through improved infrastructure, optimism (optimistic people borrow to consume and invest more), and higher incomes. A virtuous upward spiral and the opposite of fiscal austerity which is a vicious downward spiral.

The lower cost base makes exports more competitive and thus can improve the current account too.

Past trends show the US economy can tolerate negative fiscal flow rates of up to -1.09% to -2.83% before tipping over into a stock market panic and recession. We are thankfully not there yet. With wise economic management of the sector fiscal flows, there is no need for any "Minsky Moment" recessions or related stock market panics.

There is still opportunity and upside pre-programmed into the largest and most powerful stock market on the planet, and an investor wishing to do so can use the following ETFs to maintain a diversified exposure.

One can get investment access to the U.S. via these ETF funds.

  • Guggenheim S&P 500 Equal Weight ETF (RSP)

  • iShares Global 100 ETF (IOO) tracks the S&P Global 100

  • iShares Core S&P 500 ETF (IVV) tracks the S&P 500

  • SPDR S&P 500 Trust ETF (SPY) tracks the S&P 500

  • Vanguard S&P 500 ETF (VOO)

  • iShares Russell 2000 ETF (IWM) tracks the Russell 2000

  • iShares S&P 100 ETF (OEF) tracks the S&P 100

  • Guggenheim S&P 500 Pure Growth ETF (RPG)

  • Guggenheim S&P 500 Pure Value ETF (RPV)

  • SPDR Dividend ETF (SDY)

The condition of the U.S.A economy is of world importance as it tends to be the tail that wags the dog due to the U.S.A being 25% of world GDP.

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.