A tax cut like the one President Trump is proposing is supposed to work something like this: Taxes are reduced to, say, a top rate of 20 percent and then quickly, all taxpayers — individuals and corporations — become jubilant and start spending like crazy.
That, in turn, leads to an economic boom that brings extra tax revenue into the US Treasury. The added revenue, according to the plan, far exceeds the amount of money lost via the lower tax rate and, therefore, the economy booms.
That’s how it is supposed to work — and I sincerely hope that the story ends there.
That’ll mean businessman DJT found a way to stimulate the US economy that the career politicians of both parties missed or were too afraid to try. Hooray, for Donald! He’ll go down in history as one of the best presidents ever.
But . . .
I should mention right about now that there are possible side effects to the “phenomenal” — yet still un-detailed — tax cut that Trump is suggesting. And these unexpected side effects could, just as easily, turn him into one of the worst presidents ever.
I’m strongly hoping that they work as intended, but let me go through some of the worst case scenarios because — well, just because that is what columnists are supposed to do.
Problem No. 1: The US debt soared to just below $20 trillion under former President Obama and the current growing deficit — $552 billion in 2016 — could force the debt to go over that noteworthy, scary level by late March, just when Washington cherry blossoms are at their peak.
And, because of other borrowings by Washington, the deficit actually climbed by $1.4 trillion in the fiscal year that ended last September, but that’s a story for another day.
The key number here is $2.99 trillion, which is the amount of money that the Treasury Department collected in taxes in 2016. Obviously, that figure will go down by some amount and the deficit will rise if President Trump gets his way on the tax cuts without any offsetting increase somewhere else in revenues being paid to the Treasury.
So, the worst case on the budget front is that Washington could bleed money even faster than it already is. And this is very likely to be one of the main concerns that even Trump’s Republican colleagues will have when the tax cuts go before Congress.
Problem No. 2: What if companies and consumers don’t spend their extra income on goods and services as Trump hopes? What if consumers decide to use Trump’s tax cut to pay down their credit cards? And if companies use the cash not to build new factories or expand existing factories but rather to buy back stock?
Neither of those moves really helps the economy in the near term — while very much in the near term, the deficit will balloon.
Many executives are inclined to buy back stock because their compensation is tied to the price of their stock or to whether or not their earnings per share increase by a certain amount.
So if profits go sideways, a company’s EPS can still go up — and the CEO will get rewarded — if there are fewer shares in circulation.
But there’s another even more intriguing thing that could happen if executives decide to use Trump’s tax cut to repurchase shares.
As I’ve been saying, right now the chief gauge of stock prices says there’s a market bubble. The per-share price of S&P 500 companies is traditionally about 14 times earnings per share.
Right now, depending on how you measure it, these price-to-earnings ratios, or P/Es, could be nearly 75 percent too high.
That’s good for market investors but not good for deficit hawks or the economy at large.
Problem No. 3: In addition to the tax cut, Trump wants a massive increase in infrastructure spending. And that can make the deficit go boom.
As your parents used to say, don’t spend what you don’t have. But Trump is going to ignore that admonition.
Problem No. 4: Trump’s feud with China.
The red-hot rhetoric voiced during the campaign about Beijing being a currency manipulator has cooled of late, but it could lead to problems because China owns more than $1 trillion of our bonds.
If China gets angry enough at Washington, it could start selling US bonds. That would be trouble. In fact, even if China stopped buying bonds, interest rates would rise and the US economy would be hurt.
Plus, trade between China and the US — already under a political microscope — could be further impinged. A lot of US companies would be hurt if a trade war starts between the two countries.
But even here, Trump seems to be moderating his stance by recently having a cordial phone conversation with Chinese President Xi Jinping.
So what will it be? Great president? Horrible president? Somewhere in between president?
We probably won’t know for a long while — and when we do, the course of things will likely be irreversible.
So better keep your fingers crossed.
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