The Election and the Economy


The Election and the Economy

Chief Economist Scott Brown discusses what the election results could mean for taxes, federal expenditures, the national debt, and economic growth.

November 9, 2016

Heading into Election Day, polls suggested that Hillary Clinton would likely win enough Electoral College votes to gain the presidency. However, given the uncertainties in polling results and turnout, Donald Trump still had a path to victory. It boiled down to the key battleground states. He won Ohio, where polls had had him ahead. He won Florida and North Carolina, where the two candidates had been polling neck and neck. That left him with a good chance to win if he could flip one of Hillary’s “firewall” states, Pennsylvania, Michigan or Wisconsin, where she had been polling ahead in each. He won Pennsylvania and Wisconsin, lifting him over the 270 Electoral College votes needed.

A couple of weeks before the election, Democrats appeared to have a strong chance of regaining control of the Senate. The Republicans were defending 24 seats this year. The Democrats were defending 10 and needed to pick up four seats (five if Trump won) – they led in six of the Republican-held states. Instead, Democrats flipped just two seats, leaving control with the Republicans. Republicans also retained control of the House of Representatives.

With Republicans controlling both chambers of Congress, President Trump should be able to achieve many of his campaign proposals. Trump, like Hillary, promised more infrastructure spending. However, getting that through Congress may be tough. The House no longer has earmarks, which makes it difficult to reach a broad agreement on additional spending. Moreover, members of the Freedom Caucus, an extension of the Tea Party Republicans, are expected to resist more spending.

The one area on which all can agree is tax cuts. The nonpartisan Tax Policy Center estimates that Trump’s proposed tax cuts would reduce federal revenues by $6.2 trillion over the next 10 years, and with the added interest expense, they would add $7.2 trillion to the national debt. While tax cuts provide some support for economic growth, we’re unlikely to see much of a boost when they are concentrated at the high end of the income scale. The economy is already close to full employment. Hence, large-scale tax cuts may be more likely to fuel bubbles.

The budget deficit and national debt (which is the accumulation of past deficits) received little mention during the election. It’s said that the federal debt only matters when the other party controls the White House, and it wasn’t clear who would win. Additional infrastructure spending and large-scale tax cuts, along with increasing expenditures on Social Security and Medicare, will require the federal government to borrow more. Bond yields will be higher than they would be otherwise. The extra interest income should be helpful for retirees and other savers, but we’ll also see increases in mortgage rates and the cost of business borrowing.

Could faster economic growth boost revenues and offset the tax cuts? Not likely. While there is still some slack remaining in the job market, labor force growth has slowed, limiting the upside potential for growth. Between 1960 and 2000, the labor force growth averaged 1.8% per year. It’s expected to average about 0.5% per year over the next 10 years. Federal Reserve officials believe that real GDP is likely to be around 2% in the near term, but will likely slow to about 1.7% on average over the long term (vs. the 3.0-3.5% pace of a few decades ago). That’s simply a reflection of the demographics (slower population growth) and expectations of moderate growth in labor productivity. Advances in robotics and artificial intelligence could lead to some significant labor savings in the years ahead, with displaced workers helping to relieve some of the impact of slower labor supply, but it’s hard to say with any certainty. Additionally, we could increase immigration to offset the demographic shift.

The bottom line is that financial market participants face uncertainty in the near term. How good will the relationship be between Trump and the establishment Republicans in Congress? Will Vice President Pence take a key role in day-to-day operations? What will be the makeup of the new administration, and what will its priorities be? Longer term, the population dynamics (the aging population) should restrain the economy’s potential growth rate, leading to a more challenging environment for investors.

Opinions expressed are those of the author and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or any forecasts will occur. Investing involves risks including the possible loss of capital. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision.

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