24.03 Weekly Viewpoint : US – The long and winding road to reform has just started: the finish line is still far away

The upheaval of political balances following the November vote in the US has the potential to radically change the economic scenario, with a mix of structural reforms and other measures (tax system, healthcare, spending on infrastructure and defence, protectionism, immigration, deregulation)…..

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However, the broad scope of the administration’s agenda is still extremely uncertain as for details and timing, also because it requires coordination with Congress on a number of issues. Therefore, our baseline scenario for 2017 is largely unchanged compared to December: we forecast growth at 2.1% in 2017, 2.5% in 2018, and 2.3% in 2019, and a return to potential growth as of 2020. Our scenario is based on two assumptions: 1) the tax reform will not be approved before 2017Q4, and will reap economic effects starting in mid2018; 2) the net effects of the new measures should be moderately expansionary (+0.4-0.5pp over two years), with likely major redistribution among business sectors and households, and possible downside risks (protectionism, regressive fiscal policy, slower labour force).

The Administration’s agenda covers several themes:

1) health care,

2) taxes,

3) discretionary spending (stronger spending on infrastructures and defence, lower on other items),

4) deregulation,

5) immigration,

6) delocalisation and international trade.

The first three themes require coordination with Congress for legislation, and will probably result in measures with moderately expansionary net effects on growth. The other three, on which the President has a free hand, have potentially negative implications for both domestic and global growth, in light of the administration’s strong protectionist bias: the risk of trade wars and of growth being held back by slower labour force growth should not be underestimated.

The health care reform is the first major item on the legislative agenda. The debate on the American Health Care Act (AHCA) has laid bare the deep differences within the Republican party, split between conservatives in the House and centrists in the Senate. At the time of our writing, the House vote is still uncertain and, even if positive, will ratify a compromise unsatisfactory for all sides, partly achieved thanks to Trump’s active involvement. Moreover, passage at the House does not guarantee a favourable vote at the Senate. Finally, the President’s standing is fragile, in light of the decline of his approval rate, which has deepened after confirmation of the investigation on the ties between the Trump campaign and the Russian government. Whatever the outcome of the healthcare vote, the AHCA path indicates how hard it will be to move on the next reforms, equally relevant for the electorate and even more so for the markets, such as the tax reform and infrastructure spending.

The main focus will be on the tax reform. The starting point is the Ryan plan, which includes:

a) for businesses, changing the taxable base from earnings to cash flow, with territorial correction (excluding imports and exports), tax rate cuts, a widening of the taxable base, repatriation of earnings, and immediate investment expending;

b) for households, fewer and lower tax rates on personal income and capital gains, abolition of estate and gift taxes, and smaller deductions.

The forecast impact over 10 years on the cumulated deficit is an increase of 2.4 trillion dollars (static estimate) and between 0 and around 400 billion dollars (dynamic estimate). It will be hard to reach an agreement in Congress, given the major redistribution effects between industrial sectors and household income brackets. The territorial correction factor is crucial, as it is estimated to generate revenues of around 1.1 trillion over 10 years, in part “financing” other aspects of the reform, as well as encouraging the relocation of production and quenching the multinationals’ tax avoidance. At the present stage, it is hard to predict which elements of the Ryan plan will survive negotiations, although the approaching of the midterm elections in 2018 means there will be a strong chance of an agreement being reached on the reform by early 2018. In our view, the combination of measures included in the reform will result in major redistribution effects, likely much larger than the net expansionary effects, and in moderate positive support to growth in 2018-19. However, many months of battling among Republicans lie ahead, and will require a credible President: therefore, the process promises to be far from smooth

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