ray dalio tax reform

Ray Dalio Reveals The ‘Tragic’ Aspect Of The GOP Tax Plan

"... won’t have any notable effect on our biggest economic, social, and political issue, which is the conditions of the bottom 60% and the growing disparity with the top 40%."

By Ray Dalio as posted on LinkedIn

When we look at the tax plan holistically, it looks to me like it’s a short-term minor boost to the economy that will have some minor positive longer-term impacts, but by and large it doesn’t deal with the impediments that are holding back investment and productivity in the US economy, and it won’t have any notable effect on our biggest economic, social, and political issue, which is the conditions of the bottom 60% and the growing disparity with the top 40% (especially the growing disparity between the bottom 90% and the top 10%).

In the short term, the tax law changes and regulatory reductions will provide a very modest one-time boost to after-tax incomes that will be stimulative.  How “good” the tax law changes are depends on one’s own perspective because some things will benefit and hurt some people more than others—but, net, it won’t be big.  For example, it will typically move after-tax incomes by about 0.5% in total, which will be made up for by a nearly comparable increase in the budget deficit (which doesn’t come at no cost).

The reforms to the structure of corporate taxes at the core of the bill will certainly make the US a more attractive environment to do business, but the impact of those changes is likely to be small relative to the improvement that could be achieved by investing more in things like infrastructure and education, which more directly boost productivity (see for our full studies on what makes economies succeed and fail).  To help convey the issue about infrastructure spending, the table below shows how US infrastructure compares to other developed countries (from the World Economic Forum)—i.e., it shows how the US lags significantly in rail and internet speeds, and is more middling in road infrastructure.  Our infrastructure is in desperate need of improvement.

The main impediments to making such investments are the worry over increasing government debt and the desire to make sure spending will pay for itself. While it’s really important that everyone tries to make sure that borrowed money is put into things that produce returns that are large enough to make debt service payments, that is not the most important thing.  In being very cautious about making sure that happens, productivity-enhancing debt-financed investments might not happen.  So, the real question is whether one would rather a) have significant investment development, risking it not fully paying for itself (in which case some of it, such as 20% or 30%, might have to be written off over time), or b) not have significant investment development and avoid that risk.  If one looks at the mechanics and consequences of these two choices, Path A is a better choice than Path B if the debt is denominated in one’s own currency.  For example, if one does the calculations in order to look at the consequences of a) building something like a subway system and having to write off 20-30% over 15 to 20 years or b) not having the subway system, most people would choose Path A.  And, if you look at the consequences for countries that chose Path A versus Path B, most people would prefer the conditions of countries that chose Path A.

For example, China chose Path A, so it has more debt and more and better infrastructure than Russia, which chose Path B.  While there were of course other factors at play that affected some of the differences in how they evolved over the last 20 years (since the old-style communist systems ended), the choice between Path A and Path B was the most important.  By the way, almost 100% of the differences in outcomes were due to this choice and other economic policy choice differences.  They are only two examples among many that show what is consistent with an examination of how the machine works that should lead one to favor Path A over Path B.  For your reference, I say this based on a sample size of about 80 countries.

Right now, we are favoring Path B.

So, while the tax bill will stimulate growth in the short term, we won’t get much long-term mileage out of it in comparison to paths to direct stimulus spending to areas that hit the core issues holding back US productivity.

There’s a tremendous opportunity cost arising from common sense sorts of things not being done or being cut back on—from not investing in infrastructure because of budget concerns and regulatory bureaucracy, to not improving education for similar economic and bureaucratic reasons.  So we’ll do the tax adjustment tweak and the regulatory tweak—a little bit here and a little bit there—but we won’t change things materially.  In other words, the headline is that we’re still not dealing with the bigger issues.

But, to reiterate, there is some economic stimulation coming from changes in the tax law and coming from reductions in regulations.  We will get them, and they will fade as the economy adjusts to them.  They will be relatively small, and they won’t come without costs.

I’d like to digress a moment to talk about the politics surrounding this situation because it’s a big deal in leading to this outcome and the future of our country.  There’s a war going on, and biases are entering into the choices being made so there is not decision-making based on what is good for the whole so much as decision-making based on what one group that has more power wants relative to what the group that has less power wants.  That’s the case, whether it’s the left/Democrats or the right/Republicans that has more power.  So, right now what we are seeing is policies resulting from those who genuinely believe Path B is better than Path A and who are in the group that has the power to carry its vested interests forward rather than in support of the well-being of the whole.  And we certainly will not deal with the gap and the conditions of the bottom 60% (i.e., the majority).  Once again, I’d love to see a bipartisan commission use metrics of the conditions of the bottom 60% to see if they’re improving or worsening, as well as metrics of the gap between the well-being of the top 40% and the bottom 60% to see if it’s widening or narrowing.  That way, it will be crystal clear whether or not needed changes are being made.  Based on such metrics, we would see that no significant needed changes are being made.  That’s tragic.


12 comments on “Ray Dalio Reveals The ‘Tragic’ Aspect Of The GOP Tax Plan

  1. Erik Ogard

    I have been reading Ray Dalio’s commentary since mid 2008. He’s been mediocre at best. Lot’s of big misses at highs and lows. He’s a far better businessman than investor. He has been a very profitable business. Everything else? Meh.

    • lol. he runs the largest hedge fund on the planet.

      he’s done ok on the investing front.

      • Erik Ogard

        Yeah, he does. I give him credit for that. But I was turned off by his chicken little-esque call for the end of capitalism and markets as we know them at the beginning of 2009….the bottom. He, of course, was selling risk parity….which worked out really well for him. Investment advice? Meh.

  2. The real tragedy of the tax plan is that it adds $1.4 Trillion of debt (if there is no recession soon) and much more debt if we do have a recession soon, to an already horrendous Federal balance sheet.

    At some point the credit markets will say No Mas, U.S debt will be downgraded, and a crisis will follow.

    No one seems to care.

    • Erik Ogard

      True. We need to fix the the entitlement programs, balance the budget, and reign in much of the spending. We may have one last window to get this right before all hell breaks loose. A half a generation at best. Personally, I think as part of the fix we should do 100 year bonds and refinance the entire debt by locking in the lowest rates possible. We have one chance.

  3. There will be a further shift in the tax burden away from the rich and onto the middle class. Since 1966, there has been a tremendous shift in the tax burdens away from the rich on onto the middle class. Corporate income tax receipts, whose incidence falls entirely on the owners of corporations, were 4% of GDP then and were 1.77% in 2016. During that same period, payroll tax rates as a percent of GDP have increased dramatically from 3.27% in 1966 to 5.95% in 2016.

    One does not have to be a Keynesian to see that shifts in income to those with lower marginal propensities to consume will cause an increase in savings and a decline in consumer spending. The wealthy clearly have lower marginal propensities to consume. As I explained in a Seeking Alpha article “A Depression With Benefits: The Macro Case For mREITs”:

    “…Shifting income to the rich by taxing dividends, capital gains, inheritances and corporate profits much less than the tax rates on wages also tends to make more funds available for investment since when the investment is taxed relatively less, more funds are made available for the investment. That would also put downward pressure on interest rates.

    The primary change that has fundamentally changed the economy can be best described by Warren Buffett, CEO of Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B), who said, “Through the tax code, there has been class warfare waged, and my class has won,” to Business Wire CEO Cathy Baron Tamraz at a luncheon in honor of the company’s 50th anniversary. “It’s been a rout.”

    The forces driving inequality through the class warfare that Warren Buffett points to are cumulative. It is the compounding effect of shift away from taxes on capital income such as dividends, capital gains and inheritances each year as the rich get proverbially richer which is the prime generator of inequality.
    This cumulative shift of wealth from the middle class to the very wealthy has profound impacts on the economy and securities markets. It creates a cycle where initially the wealthy pour significant amounts into investments they perceive to be safe. This can first cause an increase in economic activity. In 2005 many considered mortgage-backed securities with adjustable interest rates to be essentially risk-free. This was especially true for those rated AAA by Moody’s and S&P. This resulted in overinvestment in the real estate sector. The middle class eventually could not service the mortgage debt on their homes nor could they buy enough goods at shopping centers and department stores to generate enough funds to prevent many residential and commercial mortgages from defaulting….”

    • Totally agree.
      I am 67 my wife is 65. We just got handed a very small tax CUT of less than $1000 in 2018.
      It is sure to come back and bite the .1% when we cannot service our debt.
      Karma is……

    • Precisely, the middle class is being culled for profit. We will soon have Serfs and Aristocrats with nothing in between.

  4. ….when they realize that their day to day survival is dependent on the remaining 99.9%.

  5. While critics of the Republican bills correctly call it war on the middle class, a more accurate critique would be to call it war on wage earners. Middle-class households that do not primarily live on wages or pensions but rather derive their income from dividends, profits or inheritances will come out ahead. Likewise, those whose very high incomes come solely from wages will do worse. It is likely that many of those who now are paid salaries will try to reorganize themselves so that their salaries are now pass-through business income, which is to be taxed at a much lower rate than wages, salaries or pensions.

    As was seen in Kansas, where the rate paid by pass-through entities was reduced so that it was advantageous for those collecting salaries to reorganize themselves into pass-through entities, many highly paid individuals did so. Bill Self, the state’s highest paid employee, does not pay state income tax on millions he earns as the University’s men’s basketball coach since he uses a Limited Liability Corporation to be compensated for his services rather than a salary.

    Various Republican officials have asserted that the new tax bill will put procedures in place to make sure that all personal service income such as wages, salaries or pensions will be taxed at the higher rate. This procedure would involve determining for all pass-through entities what “reasonable salaries” are for the owners of the pass-through entities. It is mind-boggling to consider how many more Internal Revenue auditors will be needed to make those “reasonable salaries” determinations for the millions of pass-through entities. So much for a simpler tax code.

    Whether it is labeled a war on the middle class or a war on wage earners, it will be a mostly a massive shift of the tax burden from the wealthy and on to everyone else. Shifting the tax burden away from the rich and onto the middle class will eventually reduce economic growth. The question is how much harm will be done by the tax bill and how long it will take for the economic weakness to manifest itself. Related to this is the chance that one of the two classic risks to investors emanating from Federal Reserve action described above will occur before the eventual economic weakness manifests itself. Both of the scenarios of classic risks to the securities markets from Federal Reserve action last only until economic weakness is obvious to such an extent that the Federal Reserve changes course and reduces interest rates…”

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