President Trump will deliver an address to the nation before a joint session of Congress this evening. In particular, investors will be listening for clues as to whether the president supports the border adjustment tax (BAT), which is a key feature of House Speaker Paul Ryan’s (R-Wis.) tax reform plan.
Moreover, market participants are wondering whether the president will provide any other details on his administration’s priorities. Our best guess is that the president will not directly mention the BAT but will highlight the necessity of increasing economic growth and worker wages, both of which have lagged previous economic cycles by massive margins.
{mosads}In this regard, tax reform (combined with sensible deregulation) will be instrumental for President Trump to achieve his goal of faster GDP growth. Below is how we see Trump’s economic policies evolving.
The president knows that the better the economy performs, the higher his approval ratings will go and the more political capital he will acquire. This will ultimately allow him to tackle other parts of his agenda. Therefore, we believe his commitment to addressing the Affordable Care Act (ACA) first is largely symbolic. In practice, tax reforms could be implemented before substantive changes to the ACA are enacted.
The fastest way to get the economy moving is to cut taxes for U.S. households. The administration has highlighted middle class tax relief. This can be done quickly through budget reconciliation, which means that the policy would be in place for only 10 years before tax rates revert to their present levels. These tax cuts will be dynamically scored, which means that, on paper, they will be revenue neutral.
They are also likely to be accompanied by a reduction in itemized deductions and other exemptions, which would help defray the cost of tax cuts. The outcome would be a sharp, albeit temporary, jump in real consumer spending, similar to what the economy experienced during the 2003 to 2004 Bush years. Individual tax reform could be passed by June. Is this aggressive? No — Bush signed his tax cut into effect in June.
After individual tax cuts, the administration could work on corporate tax reform in a bipartisan way in order to make the legislative change permanent, meaning the bill will be passed with at least 60 votes. Is this possible? Yes.
There is more bipartisan support for corporate tax reform than is often assumed. In addition, corporate tax reform will be tied to infrastructure spending, where there is also some bipartisan agreement for various government initiatives.
Why will corporate tax reform and infrastructure be combined? The reason is simple — the repatriation of profits by overseas foreign subsidiaries will be used to help initially fund the infrastructure plans.
Because all of this is complicated, bipartisanship often takes a lot of time as there is inevitable give and take. Therefore, a deal probably would not come into form until very late in the year. This is why the administration needs to deliver the individual tax cuts first and quickly.
What about the border adjustment tax (BAT)? There is a good chance we will get the BAT, or at least some version of it, because the tax would accomplish several things the administration wants to achieve. First, it would allow legislators the ability to massively cut the U.S. corporate tax rate (from 35 percent down to 20 percent, possibly lower).
Second, it would make the tax system much more efficient, which would make the U.S. more globally competitive. Companies would have less incentive to pursue inversions and collectively spend billions of dollars trying to reduce their tax bills.
In addition, with low corporate taxes and less regulation, the BAT would also encourage more firms at the margin to relocate to the U.S. In turn, this would slow the pace of outsourcing/offshoring and bring some jobs back to the U.S.
However, given the controversial nature of the BAT and some of its complexity, which we did not mention here, we doubt the president will mention it explicitly, at least not tonight. Rather, we expect President Trump to simply set the table for what should be a long and drawn out negotiation on how to achieve needed tax reform.
Joseph LaVorgna is a managing director and the chief U.S. economist for Deutsche Bank Securities. He is regular guest on multiple CNBC programs.
The views expressed by contributors are their own and not the views of The Hill.