IntelDigest

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

MAY 10 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

Before starting a series on “Work in America” next week in IntelDigest, we finish a discussion of the current investment climate and economic landscape.  Please feel free to review our April 26 and May 3 issues for our exposition on several areas of investment which have high growth potential going forward.

In those issues, we stated that we have turned away from the broader U.S. market in equities, and have narrowed our focus.  We are not actively selling, but have tightened Stop Losses in anticipation of a market drop.  At the same time, we identified very specific areas where we have continued to invest, either by stock purchases or by Shorting sectors which have fundamental problems.

The primary reason for the interruption in the Bull Market can be traced directly to the Nation’s Capital.

The Political Millstone

The reaction of the markets to Donald Trump’s election was a surge upward, on the theory that having a Capitalist in the White House would be Good-for-Business.  From November through February, we had the Trump Bull Market in large-cap stocks, especially banks and companies in construction and materials … companies which would benefit from a vaunted Trillion Dollar Infrastructure program.

But, the reality of a Trump Presidency, and continued inability by Congress to get things done, has taken the air out of the Bull.

Because both financial markets and a large segment of the American Public are losing confidence in the ability of the Trump Administration and Congress to adopt stimulus measures for the U.S. Economy, we have entered a holding pattern in the broader markets.  We believe that significant advances in the markets will resume only when Tax Reform becomes a reality … Fall of 2017 at the earliest, and perhaps not until Spring, 2018.

Some have taken an optimistic view that the Trump Administration can produce economic gains like those of the Reagan years.  After all, Donald Trump has entered the White House, as Ronald Reagan did in 1981, as an atypical candidate, espousing a radically different economic program to spur a struggling economy.

However, that’s where the similarities end.  Reagan enjoyed substantial public support and was elected by a majority. Trump was not.

Even Reagan’s critics and opponents would acknowledge that he was an engaging personality.  He exuded a humility, optimism, good humor and diplomacy that the current President lacks.

More importantly, the economic landscape today is far different from 1981.

The decade preceding Reagan’s election was characterized by high inflation, double-digit interest rates, and steadily rising unemployment.  The financial markets had been stagnant, but the national Debt was not out of control.  The Debt-to-GDP (Gross Domestic Product) ratio was at just 35% when Reagan took office.

As a result, Reagan was able to run large stimulating deficits and increase the Debt-to-GDP ratio significantly from 35% to 55% during his term in office, without putting stress on U.S. borrowing capacity or credit.

Economic conditions today … not to mention demographics … are a polar opposite from 1981.  And, the Debt-to-GDP ratio stands at 105%, which was last seen at the height of World War II.

The point is that a Reagan-style stimulus program would blow up the National Debt, which already stands at $20 Trillion.  There are very few choices available to improve our economy going forward, and the best choice is comprehensive Tax Reform.

So, every delay in accomplishing comprehensive, stimulative Tax Reform puts the American economy further and further into the hole.  This is the issue which should be all-consuming to the President and the Congress until it is done.  Yet, they have allowed less-important matters to waste precious time.

 

 

As mentioned at the top of the letter, we have identified specific sectors which still have growth potential this year, and we set out our Thesis on each investment option in the prior issues of IntelDigest.  We offer one more Thesis, below, pertaining to Municipal Bonds.

Regular readers know that we have generally avoided Bonds over the last few months for a number of reasons, including the vast amounts of debt taken on by large corporations during the low-interest environment of recent years.  In addition, the promises of the Trump Agenda would bring about strong economic growth, increasing inflation, and a mushrooming Federal Deficit which would be fatal to your Bond portfolio.

However, as economic stimulus continues to reside on the back burner … probably until 2018 … we see value in Municipal Bonds going forward.

Thesis: Municipal Bonds

Every portfolio should abound with assets which produce regular income for the investor.  Income Assets could include bonds, preferred stocks, dividend-paying common stocks, real estate investment trusts (REITs), master limited partnerships (MLPs), or municipal bonds.

A Municipal Bond (Muni) is a loan made by the investor to a city, county, state, or other government entity (such as a water district).  These loans are used to finance roads, schools, public buildings, et al.  The investor receives the government promise of regular interest payments, and repayment of the principal, in full, at a specific date (if not sooner).

Municipal Bonds have been very popular with investors for decades because of the very consistent income and safety of the principal.  Despite some concerns for the safety of Munis in the aftermath of the 2008 Financial Crisis, statistics continue to show an extremely low incidence of default on investment-grade Munis.

Another factor favoring such an investment is the preferred tax treatment of Municipal Bonds.  You can find, today, safe Munis and Muni-Bond Funds which yield around five percent (5%).  Tax laws allow an exemption from federal income taxes (and some state income taxes) for Muni-Bond interest.  So, for example, a Taxpayer in a 28% federal tax bracket would actually yield closer to seven percent (7%), when the tax savings are taken into account.

Keep in mind that some Munis are well-priced now, but an opportunity to buy at better prices will probably come up later this year.  As the proposed provisions of actual Tax Reform legislation are discussed in the media, there could be concerns about losing certain long-standing tax benefits, such as exemption for Munis and deductibility of state and local taxes.  Then, prices for Municipal Bonds and Muni-Bond Funds should be very favorable.

That will be months down the road.  We will analyze any serious proposals for Tax Reform and report on them here in  IntelDigest.  We have not yet seen any proposal which would remove the income tax exemption for Munis.  And, if Tax Reform should take away other deductions … thereby raising the effective tax rate for many Americans … then the demand for tax-free Municipal Bonds would rise.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

MAY 3 , 2017

Contact Richard Power with comments or questions.  IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

 

 

Tonight, in  IntelDigest, we continue a review of the economic landscape and investment opportunities this year.  Please refer to the April 26 issue for the beginning of this review and our exposition on three areas of investment which have high growth potential going forward.

Because people and the markets are losing confidence in the ability of the Trump Administration and Congress to adopt stimulus measures for the U.S. Economy, we are entering a holding pattern in the markets.  We believe that the broader market advance is stalling, and will not advance significantly until a Tax Reform law becomes a reality.  As we do not expect that to happen until this Fall, at the earliest, we are focusing on specific sectors which have real growth potential despite the vagaries of American politics.

 

 

Thesis: Japanese Equities

The leadership of Japan … including Prime Minister Shinzo Abe and
central bank head Haruhiko Kuroda, Governor of the Bank of Japan … are concerned about the Japanese economy slipping back into deflation, after 25 years of virtually-nonexistent growth.  They are prepared to use extreme measures to spur the economy.

The Japanese government is actively buying Japanese stocks, having already bought government and corporate bonds worth Billions of Dollars.  The leadership is willing to do a good deal more money printing, as well as investing Billions in the equities of the country’s biggest businesses.

The inevitable result will be a falling Yen, and rising stock prices.

We are invested in a fund which grows with the increases in Japanese equities, but is not seriously impacted by a lower Yen.

 

 

Thesis: Virtual (Online) Banks

Online banking organizations are the same as traditional banks, except they operate without brick-and-mortar branches.  These banks make their profit like traditional banks … borrowing money at low interest rates and lending it out at higher rates.  But they can do so with greater profit margins because they don’t carry Millions of Dollars in brick-and-mortar overhead.

Successful virtual banks concentrate on real estate investments, using leverage (borrowed money) to amplify gains on the cash invested in properties.  In fact, real estate investments are handled pretty much the same by online banks, by the biggest traditional banking corporations, and by you and me.  In each case, the buyer’s equity in a real estate purchase consists of a small percentage of the actual purchase price, with a mortgage loan accounting for the lion’s share of the money in the deal.

As an example:  a property is purchased for $500,000, with a 10% downpayment of $50,000.  The buyer’s equity in the property is 10% of the value.  The buyer is leveraged 10-to-1.  If the value of the property increases by $50,000, this is a 10% increase in the property value.  But, for the buyer, it is a 100% increase in the buyer’s equity!

This illustrates the power of leverage;  it is also a simplified, but fairly accurate, description of the operations of most of the country’s big banking companies, such as JPMorganChase.

The typical Virtual (Online) Bank accomplishes similar returns on equity with MUCH LESS LEVERAGE than traditional banks.  And, the Virtual Banks where we have invested are paying dividends of 10-11%.

 

 

Thesis: “Short” Shopping Malls

The Online Shopping Trend … popularized by Amazon.com, but expanding rapidly every year with retailers of all stripes … is draining the life out of shopping malls.  Big-box stores, high-end anchor stores, and the smaller businesses which fill in the rest of the space in the shopping malls, are all contracting or downsizing or simply putting up “Going Out of Business” signs.

This is very bad news for those real estate companies which own and/or operate mall properties.  It’s bad enough when anchor stores such as Macy’s and J.C.Penney’s announce closing dozens of stores.  But, the smaller stores … referred to as “inline tenants” … are also struggling.  This may hurt mall owners more, because inline tenants pay higher rents per square foot than anchors do.

Selling-Short certain real estate companies which own retail malls is a rational investment strategy for at least the next few years.

 

 

Thesis: “Short” Automobile Lending

Serious problems in the Automobile Lending industry center on subprime auto debt.  Auto sales have been booming over the last few years (since the Financial Crisis), but much of the increase in sales came from cheap credit extended to subprime borrowers.

Statistics show that auto loan delinquencies and defaults were up in 2016, and these trends are accelerating in the early part of this year.  Used-car prices are down;  New-car sales are down.  Delinquencies and defaults are rising to levels not seen since the Financial Crisis.

Warnings about automobile sales trends and/or subprime auto debt have been issued lately by Morgan Stanley, Bank of America, the Federal Reserve, and other regulators and debt-rating agencies.

With ever-rising delinquencies in the $1.16 Trillion auto loan market, the Federal Reserve Bank of New York has expressed its “serious concerns” for the industry.

Auto lenders will be hurt as more and more less-than-credit-worthy-borrowers default on their loans;  lenders typically have to write off part of the loans on repossessed vehicles.  More defaults also translates to oversupply of used cars and lower used-car prices.  This is bad for both auto sales and for the lenders.  For lenders, cars are the collateral for their loans.  As used-car prices fall, lenders are more exposed to larger credit losses

Our thesis is Selling-Short certain auto lenders.

 

 

Thesis: Growth of Emerging Markets

Emerging Markets, especially in Asia, have high economic growth rates, typically twice the growth of the developed world in recent years.  For example, in 2016, emerging market GDP grew at a 4.1% rate compared to 1.6% in advanced economies.

However, the higher volatility and perceived risk of emerging markets have kept the majority of investors from taking a chance on such investment.

Our thesis is that an investment fund which can control volatility by investing in the most stable companies in the world’s fastest-growing regions is worth consideration.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

APRIL 26 , 2017

Contact Richard Power with comments or questions. IntelDigest  is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

Tonight and next week, in  IntelDigest, we review the economic landscape and map out a thesis for investing in the months ahead.  It is necessary to periodically step back and take a look at one’s investment program, to determine if your suppositions about the markets are holding up, to review the performance of the companies in which you have entrusted your funds.

The bulk of these two issues will be devoted to our ideas on the best areas to invest for the remainder of 2017.  Before that, we take a broader view of the markets and political events which pull at the markets on a daily basis.

The Trump Agenda

Today was mostly an UP day (until 3:00 p.m.) in the markets because the Trump Administration finally announced its proposals for Tax Reform.  What will tomorrow bring?

As you have read in our weekly missives, we believe that Tax Reform is extremely important to the U.S. Economy, and we have bemoaned the Administration’s putting it on the back burner for the First 100 Days in order to address less-important issues.

The reaction of the markets to Donald Trump’s election was a surge upward, on the theory that having a Capitalist in the White House would be Good-for-Business.  From November through February, we had the Trump Bull Market.

However, the new Administration has failed to build on that confidence. Uncertainty now permeates the marketplace as the reality of a Trump Presidency has sunk in.  Markets have settled into a reactive pattern, ultra-sensitive to the political news out of Washington.  Will Congress be able to agree on important legislation?  Are the President’s Men up to the task?  What has the President tweeted today?

Meanwhile, it is doubtful that meaningful legislation will be enacted before the Fall … legislation which would spur growth in the Economy.  So, the upward trajectory of the markets has stalled.

As a result, we believe that many of the stocks in the U.S. markets have hit their top for the year already.  We will begin to review positions and set tighter Stop Losses in our portfolios, with the expectation that … absent some consistent progress by the Administration and Congress over the next few months … our buying opportunities are waning.

In the meantime, we have narrowed our focus for investment.  We look away from the Dow30 and S&P500, and concentrate on a few market segments, which we set out below.  We are trying to take advantage of the last-gasp market surge of the 2009-2017 economic expansion

As we expect 2018-19 to feature both a Credit Default Crisis and a cyclical Recession, we think that these last few months of the expansion bring us the best opportunity for significant investment gains for quite a while.

So, we set out our thesis on each of the sectors where we continue to invest in 2017.

Thesis:  Mobile Payments

There are two rapidly-growing trends in the world which are converging and creating a massive opportunity for investors:  digital payments and mobile phones.

Governments (including our own) have been encouraging citizens to decrease the use of Cash in the marketplace, and move to digital means for making transactions.  Some governments have banned the use of Cash in certain large denominations.  The result has been a meteoric rise in Digital Payments.

At the same time, more and more people are becoming accustomed to using their mobile smartphones for more than phone conversations and texting.  In just the last two years, paper money has been almost completely replaced by mobile phones in the major cities of China.  China has a population of 1.3 billion, and most of them use mobile phones.

You can pay for most anything in China using your smartphone, and the Chinese company which makes it possible could be the largest company in the world in a few years.

The United States has been slower to adopt these habits because we have a better financial infrastructure than most countries.  However, the growth of Mobile Payments in the U.S. has been increasing … it is definitely the wave of the future.

 

 

 

Thesis:  Machine Learning and Artificial Intelligence

It used to be that computers worked by following rules written by humans.  Today, computers are given huge data sets to examine, and use their findings to write their own rules.  This is machine learning.

Machine learning is changing the way tech companies develop products and do business, faster than anyone imagined.  Stephen Hawking, the legendary theoretical physicist, thinks that this could be the biggest event in the history of civilization.

Jeff Bezos, the founder of Amazon, stated in his recent letter to shareholders, “We’re in the middle of an obvious … big trend … machine learning and artificial intelligence … Machine learning drives our algorithms for demand forecasting, product search ranking, product and deals recommendations, merchandising placements, fraud detection, translations, and much more.”

Using what Bezos calls the company’s “deep learning” computers, he says “customers are already developing powerful systems ranging everywhere from early disease detection to increasing crop yields.”

Amazon is one of the Big Five … also including Apple, Google, Microsoft, and Facebook … which are the biggest tech companies and the five largest stocks in the S&P 500 Index.  All have market values in excess of $400 billion.

All use Machine Learning and Artificial Intelligence, although each in its own way.  Each company has its own philosophy on how to use technology and change the world. All have become world leaders in processing data and turning data into useful information, because they have created massive databases on user behavior.

They have become some of the biggest companies in America in a very short time.  And, there’s no way that a new business can compete with them, because their Machine Learning capabilities allow them to maximize their databases.

Our thesis is:  these companies will continue to grow.

 
Thesis:  Investing in China

Chinese stocks have been volatile, and have gone through a few boom-and-bust cycles over the last 20 years.  Today, as the country tries to work its way through a difficult transition from a primarily-export economy to a consumer economy, Chinese stocks are in an uptrend … in fact, they are the best-performing stocks in the world in 2017.

This uptrend is likely to accelerate this Summer when the MSCI decides to include Chinese stocks in many of its investment funds, a move which would shift Billions of Dollars into Chinese stocks over the next few years.

 

 

 

MSCI is a leading provider of stock market indexes, exchange traded funds (ETFs), and analytics.  In June, the index committee of MSCI will meet to determine when to add Chinese stocks to their indexes.

Despite the fact that China is the second-largest economy in the world, Chinese companies are not yet in MSCI index funds (although Hong Kong-based companies are included).

It is expected that MSCI will announce that Chinese companies will be included, beginning in 2018, and that the weighting of Chinese companies in the funds will increase gradually over several years.

Nonetheless, the announcement would launch a long-term trend of investment in Chinese stocks.

 
The latter half of this market analysis will appear next week in  IntelDigest.

 

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

APRIL 19 , 2017

 

Contact Richard Power with comments or questions. IntelDigest  is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

IntelDigest  will be very short this evening, as we take time to contemplate the economic landscape for the remainder of the year.  Markets seem to be making a turn, and this is a crucial moment for American investors.

It is important that we deliberate on the way ahead, so that we can offer as clear a roadmap as possible for our clients and colleagues. So, after a brief account this evening of the troubles in our path, we will produce an expansive study for next week on the best course ahead for protecting our assets.

 

The Bull Market

It is clear that the “Trump Bump” or “Trump Bull Market” has petered out.  Prospects for decisive action in the areas of Tax Reform, Regulatory Reform, and Infrastructure Renewal have waned.  The President and his men seem to be oblivious to the likelihood of coming battles over the Debt Ceiling and government shutdowns.

Little progress has been made in the First 100 Days.  Will it be possible … even by the end of the year … to make good on promises for economic growth?

Investors are no longer buoyed by President Trump’s audacious pledges, and are dialing back their expectations. It is likely that the stock markets have attained their apogee for the near-term.

So, what do you do, as an investor?

For our next issue, we will construct a thesis for the markets going forward, and posit a timetable for government action on the economy through the end of 2017.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

APRIL 12 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

In recent issues of IntelDigest, we have discussed the prospects for Tax Reform in America this year.  We have touched on the initial proposals by Congressional Republicans, and the reasons that Tax Reform is so important at this point in American history.

Today, we will conclude this series with a discussion of the roadblocks and political obstacles which could inhibit comprehensive Tax Reform.  To take the pessimistic view, the following factors are headwinds against real Tax Reform:

Shakiness of the New Administration

Contrariness of the Electorate

Dysfunction of Congress

Trump Administration

After the initial shock of the election, the stock markets began a surprising ascent, which has lasted through the first two months of the Trump Administration.  Why?  Primarily because many investors see Trump as a successful businessman, a “can-do” guy.  They reason that having a Capitalist in charge, rather than a politician, would quickly bring about much lower business taxes and a leaner federal bureaucracy.  It has been the Trump Bull Market.

Now, almost three months into his presidency, that confidence is ebbing.  It looks less likely that the Administration will succeed in the single most important program on the agenda:  Tax Reform.

We have expressed our viewpoint on two occasions in IntelDigest … the Trump White House has been inept and naive in its waste of political capital … issuing provocative executive orders and rushing into the hornet’s nest of healthcare … rather than beginning with the most important programs which can increase jobs and grow the economy.

How can people who ran a successful American presidential campaign be so maladroit in the area of governance?  How can a candidate who seemingly “heard” the common man so well during the campaign, now be so tone-deaf to the legislators with whom he must craft vital legislation?

As a result, Trump’s First 100 Days will pass without any forward progress on the most important issues of the day. Investors’ initial enthusiasm is being tempered, and markets will settle back into a “wait-and-see” mode while the Administration tries to form a rational agenda.

The markets are hoping for a miracle-of-sorts from this Administration.  If the year ends without significant tax and regulatory reforms … and a job-creating Infrastructure package … markets will have a sharp fall.  The 2016 Trump Bull Market will morph into the 2017-18 Trump Bear Market.

The Contrary Voter

Whatever tax proposals will come down the pike … from either Congress or the Administration … Public Opinion is sure to be ardent and loud.  How will that influence the legislative process?  Will the public support tax increases or benefit cuts?

The Average American Voter wants two things from the government:  less taxes, and more benefits!  All too often the attitude is:  Taxes are too high!  I want to pay less.  But, don’t touch my benefits!  Or my family’s benefits!

In order to reduce the Debt, a Tax Reform package will have to include incentives to grow the economy, and reductions in government costs.  The annual budget deficit has been running around $500 Billion.  Where do you cut?

Consider the current costs of government in the United States.  Healthcare costs over $1.1 Trillion.  Social Security is another $1 Trillion.  Entitlement programs for seniors and low-income families (food stamps, disability, affordable housing, earned-income tax credits, childcare tax credits, et al) add another $550 Billion.  Defense spending is at $620 Billion.

 
Congress

Where to cut, indeed?  The one constant trait of U.S. Members of Congress over the last few decades has been the universal abdication of duty … by both Republicans and Democrats … to control federal spending.  The National Bank Account was briefly in surplus during the Clinton Administration;  however, over the last 17 years, Congress has allowed the National Debt to run wild.

Who thinks that Congress will make the hard choices to balance the budget now?

 

 

Needs To Be Addressed

The country’s needs are many, and comprehensive Tax Reform is needed to address these needs:

The National Debt creates a drag on growth, so the Debt has be brought under control.

Medicare and Social Security expenses are going to rise inexorably over the next 20 years as the Baby Boomer generation grows older and requires more services. Unfunded liabilities in the $ Trillions will come due.  Only an American economy running at high speed … enabled by a favorable tax system … will make it possible to meet those obligations.

Entitlement programs will need to be re-structured in order to extend their useful lives.  Yes, that means reductions in benefits, raising eligibility ages, means-testing, et al.

Our Healthcare system has been distorted for at least three generations, and healthcare costs have been skyrocketing … at double-digit annual rates … for at least 35 years.

Americans need jobs.

The ratio of the tax-paying private sector vs. tax-consuming government sector must rise again to at least a 3-to-1 rate.

The purpose of Tax Reform is NOT JUST to collect enough taxes to pay for government services.  The Tax System should provide motivation and incentive to American businesses to hire more workers and grow our economy.

Comprehensive Tax Reform … which could take several years to enact … could eventually address each of the needs listed above.  Start with bringing the federal budget into balance through budget cuts and business-growth incentives enabled by changes in the tax code.

Change the corporate tax structure to put our businesses on an equal footing with international competitors;  better yet, the U.S. tax code could make American businesses dominant, and encourage foreign businesses to headquarter here.

Tax Reform can play a role in extending the useful life of Social Security and Medicare.
.
Tax Reform can encourage efficiencies in the delivery of healthcare so that costs can come down.

Tax Reform can enable greater Job Creation by allowing small businesses and entrepreneurs to keep more of what they make and to increase their savings.

And, it is incumbent on Congress to seriously and maturely address the balance between the cost of government and the extension of needed benefits.  Congress has been “kicking the can down the road” for far too long … we are at the end of the road.

 

 

Later in the year, when the debates on Tax Reform begin in earnest, we’ll address these issues in more detail.  And, we’ll look at some radical tax revisions which could be on the table by then.

As an example, consider the possibility of replacing income taxes with consumption taxes.  Consumption taxes, such as the Value-Added Tax and the recently discussed Border Adjustment Tax, would be profoundly foreign to the American Taxpayer, but they may deserve a look.

The country is in need of investments which will create new jobs.  One solution would be to STOP taxing savings and income, and begin to tax consumption.  We have plenty of consumption;  taxing it would produce more income, which would lead to increased consumption and more jobs.

 

 

In any event, we will come back to Tax Reform when the government starts to get serious about it.  In the next few weeks, we’ll look back at the markets, and begin a discourse on the nature of Work in our American Economy.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

APRIL 5 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

We continue our discourse on Tax Reform in this issue of IntelDigest.  Please feel free to look back at the March 22 and March 29 issues, where we set out important proposals which have been put forth by the Speaker of the House, and began the discussion of the importance of Tax Reform at this point in our history.

There are a number of concerns in our economy and our system of taxation which require serious action by our leaders.  Most of these concerns should have been addressed in the past by many of those same leaders and their predecessors.

Debt

As we have pointed out in several issues of  IntelDigest, our National Debt is now approaching 20 Trillion Dollars, and unceasing Deficit Spending adds to the Debt every year. Growing the economy out of this predicament would require sustained growth of at least 3% per year going forward, and the best way to do that is through real, serious Tax Reform.

Debt can actually be beneficial, if it is used to purchase productive assets which contribute to growth. Unfortunately, governments incur Debt much too often for use in current consumption, not for productive assets such as infrastructure.

We are deep into the third-longest “recovery” since World War II, and we are averaging over a full point of GDP growth less than in previous recoveries  …  primarily because of the size of the Debt.  If the economy should fall into recession, it would truly blow out the budget, deficits, and debt, and suck us into a downward spiral that would leave us with no good choices.

Government Spending

Spending by governments in the United States … federal, state, local … now amounts to 35% of the Economy.  At the current rate of growth of budgets at all levels, the figure will be over 40% in the near future.

Cutting government spending … something which has not been done in generations … would be a start.  But, cutting spending alone would do little to reduce the National Debt.

Taxation of Productive Business

Every private Dollar which goes to paying taxes and supporting the government is a Dollar that cannot be invested in new businesses or creating new jobs.  On the other hand, greater tax-saving by Americans who are capable of re-injecting those savings into U.S. businesses is a boost to the U.S. Economy.

Empirical research has shown that as capital increases in a country, so does entrepreneurial capacity.  As that capital is taxed more heavily, entrepreneurial activity fades. Successful economies allow entrepreneurs to keep more of their earnings, so they can put them back to work in growing business.

Corporation Taxation

The United States has the highest corporate income tax rate in the world.  That heavy corporate tax burden puts us at a serious disadvantage;  as a result, more American corporations move operations or headquarters overseas every year.

The irony is that the corporate tax is only 11% of the total revenue of the United States.  If all loopholes were eliminated and the rate was reduced to 15-20%, the federal government wouldn’t lose all that much revenue.   Corporate pre-tax profits are roughly 1.5 Trillion Dollars. Lowering the current tax rate, or adopting a 15-20% flat tax, would replace most of the tax revenue currently collected. More importantly, the United States would become very tax-competitive internationally, attracting more multinational companies to headquarter here.

 

In other ways, the U.S. tax system is Short-Sighted.  Key provisions of our tax code focus taxpayers on short-term goals.  We need more long-term thinking in order to grow our economy out of the current predicament.

Tax System Encourages Debt

The current tax regime favors debt over equity.  Companies are allowed to expense the total amount they spend on Interest.  This is a significant incentive to use the Wall Street investment banks to borrow as much money as possible.  It reduces the cost of capital.

Most Americans have no idea how big or dangerous the corporate-debt bubble has become.  As of the second quarter of 2016, investment-grade corporations were spending $119 billion annually on Interest expenses, the most since 2000, just before the Tech Bust of 2001. However, interest rates are much, much lower today.  So, the debt balances are vastly higher.

U.S. corporate debt has soared from less than $3 trillion to almost $7 trillion in just the last decade.  And, a higher percentage of this debt is rated as “junk.”

Thus, American companies are now more exposed to either rising default rates or rising interest rates than they’ve ever been before.

This situation has been great for Wall Street … not so good for America.

Tax System Requires Depreciation of Assets

The U.S. tax system requires that most capital investments be depreciated over years, rather than expensed in the year of purchase.

Some items … such as computers and software … are eligible to be fully expensed in the year of purchase. However, longer-term corporate investments can only be depreciated over many years.  Inflation decreases the real value of these deductions, providing companies with an incentive to avoid making big, long-term investments.

Allowing companies to reflect their actual expenses (including all investments) in the year they are incurred would provide American corporations with a major business incentive, which would be vital to economic growth over the long term.

This would be the best chance to increase productivity in the U.S.  It is important that American companies make far more and far larger long-term investments in American productive capacity.  Our tax policy should make this easier to achieve.

Tax System Encourages Offshoring

The current trade and tax regime makes it logical for American companies to store as much value as possible overseas, and only import what they plan to sell in the U.S.

Why does every important American software maker (including Apple and Microsoft) have its international headquarters in Ireland?  By keeping their core intellectual property in Ireland, these companies can pay far, far less in taxes.  Meanwhile, they can import that intellectual property back into the U.S. (after manufacturing in China) for free.  This allows them to pay a tiny fraction of the taxes they would otherwise have to pay.  So, a great deal of their employment and capital is kept outside the U.S.  (Microsoft, for example, just spent $250 million building a new campus in Ireland.)

Change the Tax System!

Lower wages don’t drive U.S. companies to manufacture overseas.  The difference in wage rates is almost irrelevant when the costs of setting up infrastructure, supply chains, and transportation costs are factored in.

The reason that most U.S. companies set up manufacturing and research and development overseas is to avoid high U.S. taxes and regulation.

Changing just these last three components of the U.S. tax code could be done on a revenue-neutral, zero-cost basis. These three changes alone would drive U.S. gross domestic product growth from around 1% to well over 3.5% … a level which we have not achieved in more than eight years.

This is why Tax Reform is so important at this point in American history.  We need accelerated entrepreneurial activity to expand the economy and create more jobs.

We can achieve significant Tax Reform and move into a new era of growth (with attendant Inflation) … or … we slide back into a depression caused by a mountain of corporate and government debt.

 

 

InnOvation Capital & Management, LLC

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MARCH 29 , 2017

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Before we continue a discussion of Tax Reform here in IntelDigest, we’d like to offer a sobering assessment from David Stockman.  You will recall that Stockman was the budget chief in the Reagan Administration, who often found himself at odds with the Republican establishment.  After government service, he spent two decades on Wall Street, and is now a raconteur and contrarian pundit.

Stockman’s opinions on the state of things:

“There is no Republican “majority” on Capitol Hill.  There’s only a gang of factions that will form a circular firing squad around President Trump.  The Republicans will bring Trump’s legislative agenda to a thundering halt before it even gets launched.

“The immediate case in point is the campaign pledge that Obamacare would be subject to “repeal and replace” within days of the inauguration.  That didn’t happen.  And it’s not going to happen within these vaunted first 100 days.  Or even this year or next.  Instead, the so-called Republican majority will splinter.  They’ll bog down the legislative process in prolonged maneuvering and wrangling ….

“The plain truth is that if Ronald Reagan couldn’t drain the swamp way back then, how in the world can Donald Trump do it now, after 36 years of massive growth in government and debt?

“The implications for the Great Disrupter could not be any clearer.  His predecessors have used up the nation’s public balance sheet  ….  Reagan inherited a debt-to-GDP ratio of 30%.  He had wide-open space to accidentally implement giant deficits.  But Donald Trump has no running room at all with debt-to-GDP at 106%.”

We are not as pessimistic as Stockman;  but, it is important that Our Leaders address all these matters.  For our part, we will continue to focus on issues of economics, finance, law, and policy on a weekly basis in IntelDigest.

The Republican Plan – A Better Way?

Last week, we set out the Tax Reform proposals of the House Republicans, as published by House Speaker Paul Ryan in a document titled “A Better Way.”  If Congress can form a consensus over many of the business-related incentives contained in that plan, we can be encouraged that Tax Reform can contribute to kick-starting the economy.  Tax Reform actually has the interest of Congresspersons across the political spectrum, so (unlike healthcare) there is a much better prospect of garnering enough Democrats and Republicans to pass a Tax Reform Bill.

We have deliberately not addressed a much-discussed feature of the Republican plan, the proposed Border Adjustment Tax (BAT) … primarily because the chance of adopting this provision is slim.  If its chances improve markedly over the next few months, we will analyze the proposal and the underlying reasons for it.

Today, we discuss WHY Tax Reform is important.  Over the coming weeks, we will study matters which relate to American Taxation, such as the state of Work (Employment) in the U.S., the size of government, budget deficits, etc.  For today, we reduce the question to one simple truth.

 

 

The Importance of Tax Reform in 2017

Success at passing Tax Reform this year could set the tone and direction of the U.S. economy for years to come.  A comprehensive package … reached by consensus in the Congress … will affect jobs and healthcare, as well as taxes and the economy.

Here is an essential argument for lowering taxes:

Spending  by governments in the United States … federal, state, local … now amounts to 35% of the American Economy!  Governments provide a small amount of their own support.  They rely on taxes paid by the private sector. In past decades, the private sector comprised 80% of the economy, so it was four times the size of the government. Now, the private sector is barely two times the size of government.

Every private Dollar which goes to paying taxes and supporting the government is a Dollar that cannot be invested in new businesses or creating new jobs.  On the other hand, greater tax-saving by Americans who are capable of re-injecting those savings into U.S. businesses is a boost to the U.S. Economy.

Capital feeds entrepreneurial activity, which is the biggest creator of new jobs in the United States.  If lower taxation frees up more Capital to create more jobs, that is a good thing.

This is why Tax Reform is so important.  We are at a Tipping Point.  Over the last 40 years, under both Republican and Democratic Administrations, the size of government has grown relentlessly, putting greater burdens on taxpayers. And the National Debt has exploded over the last seventeen years.

Since the Financial Panic of 2008, the American economy has been growing at a rate of 2% per year (after inflation); but, the Debt increase has grown at DOUBLE the rate of the economy!

We need the Economy to grow faster than the Debt, and growth in the Economy … like the growth in employment … comes primarily from the entrepreneurs and other business owners who put Capital to work every day.

If Tax Reform can release more Capital into the Economy, allowing businesses to grow and create the jobs of the future, we have a much better chance of working our way out of the hole which our politicians have dug over these last few decades.

 

 

 

InnOvation Capital & Management, LLC

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MARCH 22 , 2017

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This week in  IntelDigest, we continue a discussion on Tax Reform, a vital factor in the strategy to grow the American economy out of the very-deep-hole known as the National Debt.  As we stated two weeks ago, the new Administration … in its zeal to overturn All Things Obama … is making a serious tactical error in tackling healthcare ahead of all other matters.  Nothing is more important than using Tax Reform to begin the process of growing the Economy faster than the Debt.

The Republican Plan – A Better Way?

So, we turn to the initial proposals to use the Internal Revenue Code to spur American business … the tax proposals of the House Republicans.  The Republican Agenda, issued by House Speaker Paul Ryan, is titled “A Better Way.”  Although it addresses a number of policy areas, we will spend the next few issues solely on the tax proposals.

We will look at both Corporate and Individual tax provisions.  Most large American businesses are incorporated;  the majority of businesses are organized as proprietorships, partnerships, or limited liability companies taxed as partnerships and subject to the Individual tax rates and rules.

If Tax Reform is going to provide the impetus to kick-start the economy, business owners among all these organizations must be able to benefit from Tax Reform and plow their tax savings into growing their own businesses and the U.S. economy.

Before we begin, we should acknowledge that it’s very difficult to calculate how much effect each of the tax proposals would have in the end.  Not only because we are very early in the process, and even the most basic tax reforms will not pass the Congress before the end of the year.  But also because of the innate ability of the American businessman/woman to “game” whatever tax rules exist in order to reduce his/her company’s exposure to taxation!

 

 

 

Corporation Tax Proposals

The Congressional plan includes the following tax changes:

• Reduction of top Corporation income tax rate from 35% to 20%

• Elimination of the Alternative Minimum Tax (AMT) on corporations

• Immediate deductions for capital investment expenditures (Depreciation)

• Indefinite carryforward of net operating losses

• Repatriation of foreign cash holdings at an 8.75% tax rate (limited time offer)

• Exemption of foreign-subsidiary dividends from U.S. tax

The following changes would partially offset the new breaks:

• No Interest Deduction on future loans

• Elimination of many deductions (except Credit for research and development costs)

The overall effect, if all these changes were to be signed into law, would be significant tax savings for large and small corporations alike, and simplification of tax compliance.

Lowering the top Corporation tax rate will benefit mostly large corporations;  they would cumulatively save many  Hundreds of Millions of Dollars, which could be re-injected into the economy.  The ability to “expense” capital expenditures in the year of purchase … rather than depreciating or amortizing over a number of years … would profit companies across-the-board.  Businesses of all sizes expend capital on plant-and-equipment … from computers and furniture and vehicles in small businesses to large-scale construction and factory equipment and fleets of vehicles in bigger companies.

Among the winners:  technology and biotech firms which would still be able to write off Research and Development Costs;  manufacturing and industrial firms which can immediately expense large capital expenditures.

A minority of businesses would benefit from a repeal of the Alternative Minimum Tax, but many more would make use of Loss Carryforward provisions, which would reduce taxes in future years.  Multinational companies stand to gain from the proposals pertaining to foreign operations.

One of the most important factors would be the potential repatriation of funds held overseas.  We have addressed this issue in  IntelDigest on several occasions.  The largest American multinationals have held large amounts of Cash overseas, estimated cumulatively at approximately Two Trillion Dollars, for several years.  The U.S. Corporation Income Tax on that sum would be about 35%;  hence, a reluctance to bring that Cash back to our shores.

However, most companies would jump at the chance to pay 8.75% on repatriated funds, and the remainder would be a welcome addition to the U.S. Economy.

 

 

Individual Tax Proposals

The Congressional plan includes the following tax changes for individuals and families, some of which apply to the small business sector:

• Reduction of the top Individual tax rate to 33% (many prosperous taxpayers can have an effective top rate close to 40% for federal income taxes alone)

• Possible reduction of top rate to 25% for self-employed and business owners

• Elimination of the Alternative Minimum Tax (AMT)

• Repeal of the Estate Tax and Gift Tax

Other proposals have less impact on the economy, but would be important to individuals and families which could benefit or be affected:

• Elimination of itemized deductions (except mortgage interest, charitable donations)

• Larger standard deductions and child/dependent care tax credits

• Streamlined education tax benefits

• Improved Earned Income Tax Credit (EITC)

Regarding the business-related proposals and their impact on the economy, a large portion of the American economy … and the largest creator of new jobs … is Small Business. Most Small Businesses are owned by people who pay Individual tax rates.  So, Small Business owners will arrange their organizations and tax reporting to take advantage of lower tax rates and expensing capital investments.

With a top tax rate of 25% applying to proprietorships and pass-through entities such as partnerships, limited liability companies, Subchapter S corporations, we will see a form of “Musical Chairs” as business owners and investors and self-employed individuals reorganize to take the most advantage of tax law changes.

But, this is NOT a bad thing.  More tax-saving by Americans who are capable of re-injecting those savings into the U.S. Economy is a very good thing.

 

We will be writing about Tax Reform for the rest of the month … outlining proposals, burrowing into details, and analyzing the probabilities for passage and implementation in the near future.

 

 

InnOvation Capital & Management, LLC

IntelDigest

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MARCH 15 , 2017

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To complete our recent discussion of the Debt Ceiling, the recent “suspension” of the Debt Ceiling (negotiated 17 months ago) ends today.  So, the hard work begins between the Congress and the Trump Administration.  The Republican President intends to spur the American economy by way of a massive federal stimulus program aimed at rebuilding the U.S. infrastructure.  However, there are significant numbers of Republicans in Congress who would oppose raising the federal Debt Ceiling in order to provide the funds for such a program.

We will see this issue increasingly in the news as Winter turns into Spring … the conflict is likely to come to a head by sometime in June.  So, look for early “fireworks” this year.

In other news, The Federal Reserve raised short-term interest rates this afternoon by another 25 basis points (0.25%).  Tomorrow, the Trump Administration will release its first Budget Proposal, which contains significant cuts to federal spending across the board, but particularly at the State Department and Environmental Protection Agency. And, elections in The Netherlands have taken place today. By tomorrow, we’ll know whether the far-right candidate … referred to as the “Dutch Trump” … has succeeded in gaining power in that country.

Keep in mind that the Netherlands vote is the first major European election of the year, to be followed by elections in France and Germany.  Later in the year, we will take stock of developments in the European Union, movement on the Brexit from the E.U., and determine if the wave of populism in Western nations is growing or petering out.

This week in  IntelDigest, we turn to Tax Reform … the discussion will begin in this issue and continue over the next two weeks.  Tax Reform is so important because it is a vital factor in allowing the U.S. to “grow” its way out of our Debt quagmire.  Even if the government is successful in doing so, it will certainly take ten years to accomplish.  But, it simply will NOT happen unless the American tax system provides the impetus to kick-start the economy.

In the December 7 issue of  IntelDigest, we published our own line-by-line policy recommendations to the incoming administration.  Congressional Republicans have recently put out their first draft of a Tax Reform program, which we begin to review, below.  Some provisions are in line with our thinking.  However, as we wrote three months ago, at the very least …

“The new administration MUST prioritize getting the national debt and annual deficit under control. It doesn’t have to be done immediately; the process can stretch over several years or even a decade. But, there must be a process in place to show The American People that this dangerous situation is being addressed ….

Allowing the Debt to grow further will just make it harder for our economy to grow out of the problem. Since the Financial Panic of 2008, the American economy has been growing at a rate of 2% per year (after inflation); but, the Debt increase has grown at DOUBLE the rate of the economy! These trends must be reversed, at minimum.”

Difficulties of Tax Reform

Government is a necessary instrument for maintaining a civilized society.  Some of you may disagree with that basic premise, but we believe that an orderly government is the middle ground between totalitarianism and anarchy.  So, for the sake of argument, let’s agree that an orderly Government is Necessary.  And, Taxation is the price we have to pay in order to pay for Government.

Everyone has reason to complain about the American tax system, but we all get something out of it.  Most people have apprehensions about making significant changes to the system … fear of losing whatever tax benefits currently accrue to them, or a more general fear of the unknown.  As a result, Tax Reform is extremely difficult to accomplish, so most Reform efforts fail.

The basic goal of any policy of taxation should be to simply raise sufficient revenue to make Government work.  But, the American Government … as it has developed over approximately 230 years … has become enormously complicated.  As has the system of taxation used to fund Government.

Some will say that our Federal Government is too large, trying to accomplish too many varied goals, with fingers in too many different pies.  If that is your view, or even if you believe that Big Government is necessary, we should all acknowledge that our tax system has evolved to the point where tax policy is used to encourage/reward certain behaviors and interests, and discourage/punish others.

As a result, the tax system has become obese, unwieldy, incomprehensible.  It creates incentives which may be counterproductive and/or out-of-alignment with rational, reasonable policies and practices.  Overbearing taxation, on one hand, or generous tax incentives, on the other, actually determine whether certain industries can exist in our society.

Tax Reform is so difficult because Tax Policy is interwoven with decades and decades of economic, social, environmental, and political initiatives, promulgated by liberals and conservatives, Democrats and Republicans alike.  One may argue that the ideal tax system would be neutral, providing a level playing field for all citizens … businesses and individuals … to deliver their goods and services, to seek their own prosperity.  But, we don’t have that … our starting point is a complex, convoluted mass called the Internal Revenue Code (Tax Code).

It would take decades for Congress to walk-back a significant amount of the Tax Code.  Constant, incremental reform should be required of our legislators.  However, an absolutely necessary first step … in the current financial circumstances … would be adopting a basic level of Tax Reform, certain measures which would help to kick-start the economy.

Both Congress and the Administration have acknowledged as much.

The Republican Plan – A Better Way?

In the next two installments of  IntelDigest, we will analyze the tax proposals of the House Republicans.  The Republican Agenda, issued by House Speaker Paul Ryan, is titled “A Better Way.”  Although it addresses a number of policy areas, we will spend the next two issues solely on the tax proposals.

So, we will end here, and dive into the plan next week.

 

 

InnOvation Capital & Management, LLC

IntelDigest

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MARCH 8 , 2017

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This week in IntelDigest, we will have the first of several weekly discussions on the subjects of Legislation and Policy, as the Trump Administration goes to battle with Congress on issues of vital importance to the nation.  The American economy is at stake in this conflict, and the actions of the White House and Congress will determine if we, as investors, finish the year on a sweet or sour note.

As we wrote in November, in the weeks following the election, the Dollar and stock markets were rallying ..

“… on the expectation that a Trump presidency will be good for business. The President-Elect has vowed to lower taxes (especially on corporations), commit Hundreds of Billions of Dollars to infrastructure spending, and reduce government regulation.”

The stock market has continued to advance since Donald Trump assumed the Presidency, on the same hope that these business-friendly policies will come to pass. However, the market strength will have to subsist on hope until the President and Congress prove that they can work together and move forward on two major issues:  (1) the Debt Ceiling, and (2) Tax Reform.  These are the topics for our discussions in  IntelDigest during the remainder of March.

In our opinion, the new President has started with some counter-productive moves.  In his zeal to overturn the Obama Legacy, he is making the same mistake that President Obama made in his first term:  focusing too much on healthcare.  As President Trump stated (without a hint of irony) in a speech to the nation’s governors on February 27, “nobody knew that healthcare could be so complicated.”

So, the hard work of governing begins …

The first draft of a Republican replacement for the Affordable Care Act has stoked criticism from both mainstream Republicans and right-wing Republicans (not to mention opposition from Democrats).  Arguments over healthcare policy threaten to impede progress on more important matters affecting the economy.

 

In addition to Healthcare, the Trump Administration is seeking to vastly reduce federal government regulation, cut the budget for many government agencies and departments, and spend a whole lot more on the Military and Infrastructure.  Tax Reform is a major issue, which we will discuss in detail over the next couple of weeks.  But, the first major battle of vital importance to the nation comes up next week … the Debt Ceiling.

 

 

The First “Speed Bump” for the Trump Administration

It is likely that two events will occur next Wednesday which will directly impact the U.S. Economy.  It is expected that The Federal Reserve will raise short-term interest rates by another 25 basis points (0.25%), as The Fed tries to put monetary policy back on an even keel (as we discussed last week).  And, the President and Congress will begin to battle over raising the Debt Ceiling.

The U.S. Debt Ceiling is a legislative limit on the amount of federal debt which can be issued by the U.S. Treasury.  As the federal government has been regularly spending more money than the Treasury takes in over the last few decades, the government must borrow to help fund operations. When borrowing pushes the national debt up to the Debt Ceiling, conflict arises.

The government must choose among cutting programs and spending, or defaulting on the Debt, or raising the Ceiling. Political conflicts have led to government shutdowns.  In 2011, a crisis arose over a threatened default of government debt … leading to a downgrade in the credit rating of The United States … when political wrangling delayed an increase in the Debt Ceiling.

In October, 2015, President Obama and Speaker Boehner negotiated an agreement to suspend the Debt Ceiling until March 15, 2017, allowing the national debt to keep piling up.  As of next week, the new President and the Republican-controlled Congress will have to come to terms on a new Debt Ceiling, or otherwise agree on federal spending limits.

 

 

History of the Expanding National Debt

We wrote, in the September 28 issue of  IntelDigest, that:

“… the state of our official National Debt … stands at approximately $20 Trillion.  Additional future unfunded government liabilities … Social Security, Medicare, Medicaid … would increase the true National Debt to hundreds of Trillions of Dollars over the coming decades.

The official Debt can only increase, as the federal government continues to spend much more than it brings in.  Boston University professor Laurence Kottlikoff has written that over 90% of federal tax revenues go to cover entitlement programs plus interest on the Debt.  ALL other federal government expenditures … including the cost of the largest military in the history of the world … has to be funded from the remaining 8-9% of revenues, PLUS more and more borrowing.”

Our national debt is close to $20 Trillion, while our national Gross Domestic Product (GDP) is approximately $19 Trillion, resulting in a debt-to-GDP ratio of 105%.   How did things get this bad?

In the first 200 years of the Republic, such peaks in the debt-to-GDP ratio occurred during major wars … the Revolutionary War, Civil War, World War I, World War II. After the wars were finished, the country worked to re-establish sound financial footing, so that the debt-to-GDP ratio always came down to reasonable levels.  As recently as the Nixon, Ford, and Carter administrations, the ratio stood at approximately 33%.

The Era of Expanding Debt began in the Reagan Administration in 1981, and has grown through Democratic- and Republican-controlled governments alike. After decades of strong economic growth and stable “real” interest rates, Reagan entered office in a time of high inflation, high interest rates, and a major recession.  He had, in his favor, a low debt-to-GDP level and sound American credit.

After Fed Chairman Paul Volcker successfully brought inflation and interest rates under control, the recession ended and the Dollar was strong.  President Reagan wielded American fiscal strength as a weapon to win the Cold War … using deficit spending and borrowing power for a huge military expansion, including the Strategic Defense Initiative anti-missile program (dubbed “Star Wars” by the press).

Reagan’s first-term tax cuts and second-term military spending ballooned the Debt and federal deficits;  the debt-to-GDP ratio rose to 55%.

The fiscal conservatives in the Reagan Administration (some of whom now advise Donald Trump) expected that tax cuts would reduce government income, and the government would be forced to cut spending in order to reduce deficits.  But, it didn’t work out that way.  Higher and higher government spending became a way of life.

Under the administration of George H.W. Bush, the deficit grew, and the debt-to-GDP ratio rose to 60%.  So, the Bush Administration negotiated a budget compromise, including some tax increases, with the Democratic-controlled Congress.  This was contrary to his “No New Taxes” pledge, which damaged his re-election chances.  Ross Perot entered the race as a third-party candidate, and Bill Clinton won the 1992 election.

The Clinton Administration was able to enjoy a period of relative peace in the world;  through lower military spending, sound monetary policy by The Federal Reserve, and a small rise in income taxes (which are at roughly the same levels today), President Clinton presided over the longest peacetime expansion of the economy in American history, and produced a small budget surplus for the first time in 30 years.

At the time of the election of George W. Bush (and Dick Cheney) at the end of 2000, the federal budget was again in deficit and the debt-to-GDP ratio was at 58%.  Although his predecessors had succeeded in holding the line on the debt level, it was still close to the highest level in history to that time.

Bush/Cheney pushed through major tax cuts in 2001 and 2003, and increased federal government spending across the board.  They adopted additional increases in federal spending for military and intelligence in response to the 9/11 attacks, and prosecuted wars in Iraq and Afghanistan, as well as military actions in several other countries.

At the same time, The Federal Reserve continually lowered short-term interest rates, encouraging speculation in banking and real estate.

By the end of the Bush Administration, the debt-to-GDP ratio was up to 63%, the national debt had grown to $10 Trillion, and the world economy was in full-blown Financial Crisis.

Barack Obama entered office during the worst financial panic since The Great Depression … the economy was crashing and jobs were lost by the millions.  The Administration’s attempts to stimulate the economy with government deficit spending succeeded, but at a slow rate of less than two percent per year.  The 2009 American Recovery and Reinvestment Act provided little “shovel-ready” infrastructure spending, and went primarily to protecting jobs of municipal workers, teachers, healthcare workers.  The Republican-controlled Congress blocked further stimulus programs.

 

 

The Way Forward

The Trump team believes that Growth is the answer to leading the American economy out of our Debt Crisis over the next decade.  Although mathematically possible, it will be a long and difficult journey, even in the best of circumstances.

But, that long journey begins next week.  In order to have the financial flexibility to pursue the Trump Agenda, the Administration will require the cooperation of the Republican-controlled Congress to increase the Debt Ceiling.  There are factions within the Republican Party which are not likely to cooperate.  So, we can expect a battle to be raging at this time next week.