Well, it’s official. I’ve run out of ways to paraphrase myself re: the reflation narrative and the damage the failure of the GOP health care bill inflicted upon that narrative.
But I’m going to give it a shot anyway because I need to introduce a good Wall Street Journal opinion piece that should maybe be on your list of “must reads” on Monday.
This whole thing – the “Trump trade” – rested on reflation. All of it. Higher yields, a stronger dollar, rising stock prices, buoyant financials, outperformance by higher tax rate companies and small caps, collapsing stock and sector correlations (think: clear winners and losers), suppressed realized vol as a result of collapsing correlations, and on, and on.
On Friday, it fell apart. No ACA repeal means: the road ahead for tax reform is now more arduous, and as for fiscal stimulus … fuggedaboutit (*Donnie Brasco voice*).
And so, yields fell. Rate differentials narrowed. The case for a structurally strong greenback was concurrently undermined. And as for the last piece of the puzzle – the voracious retail bid for stocks – well, it won’t take long for “mom and pop” to connect the dots. Especially not when main stream newspapers are out explaining just how much damage was actually done to the narrative on Friday.
So with all of that in mind, consider the following from The Wall Street Journal.
Republicans are consoling themselves that after their health-care failure they can move on to tax reform, and they have little choice. The large complication is that the Freedom Caucus’s ObamaCare preservation act has also made a tax bill much harder politically even as it makes reform more essential to salvaging the Trump Presidency and GOP majorities in 2018.
President Trump campaigned on breaking Washington gridlock, increasing economic growth and lifting American incomes. The health collapse undermines those pledges. The legislative failure is obvious, but less appreciated is that House Speaker Paul Ryan’s reform included a pro-growth tax cut and major improvements in work incentives. The 3.8-percentage-point cut in taxes on capital income would have been a substantial increase in after-tax return on investment, nearly half of the eight-point cut in the capital-gains tax rate that helped propel growth after 1997.
Now that’s dead, and so is the replacement for the especially high marginal-tax-rate cliff built into ObamaCare’s subsidies. These steep tax cliffs as subsidies phase out are a major hindrance to work, as University of Chicago economist Casey Mulligan has shown. The Ryan bill would have been a significant boost to economic growth and labor participation. The critique that it would not have helped “Trump voters” was willfully false coming from the left and uninformed on the right.
This lost opportunity now makes tax reform even more important as a growth driver, but the health-reform failure also hurt tax reform in another major way. The Ryan bill would have reduced the budget baseline for tax reform by some $1 trillion over 10 years. This means that suddenly Republicans will have to find $1 trillion more in loopholes to close or taxes to raise if they want their reduction in tax rates to be budget neutral.
Some Republicans think the health failure will concentrate GOP minds on taxes as a political necessity, but then they said the same about repealing ObamaCare after seven years of promising to do so. They flopped even though it’s unheard of for a new President to lose on his top priority so early in his term. That’s when his political capital is highest and his own party has the most incentive to deliver on its promises.
The risk now is that the health failure will make the GOP Congress even less cohesive and less likely to follow its leaders. Freedom Caucus Members sit in safe seats and don’t need achievements to win re-election. They are almost happier in the minority where they can more easily vote no on everything.
Mr. Trump lacks the political base of most Presidents, so he is hostage more than most to performance. Above all that means presiding over faster growth, which is the only real way to help Trump voters. If the GOP can’t deliver on tax reform, the Freedom Caucus will have done far more harm than saving ObamaCare.