ETF Expert Corner

AEI’s Michael Strain on Country’s “Populist Moment”, Impact of Tax Reform

January 2nd, 2018 by ETF Store Staff

Michael Strain, Director of Economic Policy Studies at the American Enterprise Institute, describes the country’s current “populist moment” and discusses the potential impact of tax reform.



Transcript

You can listen to our interview with Michael Strain by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: Our first guest today is Mike Strain, Director of Economic Policy Studies at the American Enterprise Institute. AEI is a public policy think tank. They're based in Washington D.C. and as I described earlier, Mike has an extensive background in economic policy. He holds a Ph.D. in economics from Cornell. He previously worked in the Center for Economic Studies at the U.S. Census Bureau. He also worked in the macroeconomics research group at the Federal Reserve Bank of New York. Mike is a columnist for Bloomberg View. He's been published in places like The New York Times and The Washington Post. He's appeared on CNN and CNBC and we're certainly very excited to have Mike joining us via phone today. Mike, as always, a pleasure having you on the program and Happy New Year to you.

Michael Strain: Yes, always great to be on and Happy New Year to you and Conor as well.

Nate Geraci: Mike, before we get to tax reform and infrastructure spending and the economy in 2018, you are right there in the heart of Washington D.C. You're intimately familiar with the political climate there. Can you just paint a picture for us? What's the overall mood like right now after a divisive election in 2016 and a fairly tumultuous 2017?

Michael Strain: I think the mood is that we're in for quite a bit of the same in 2018. There was no election in 2017. We had some special elections, perhaps most prominently the special election for Senate in Alabama, but the President will be back out on the campaign trail in 2018 in a major way. The fate of the Senate is up in the air. There are people who think that the control of the House is in jeopardy. A lot of the traditional things that happen in the second year of a presidential administration in terms of focusing more on politics and less on policy are expected to happen with the Trump administration as well. I think, if anything, 2018 promises to be a wilder ride than 2017.

Nate Geraci: Putting politics aside, when I look at the mood of the country, there certainly has been a movement towards populism overall and back in December, you wrote a really interesting piece where you said economics and culture collided to create our current populist moment. I was hoping maybe you can provide some color here for our listeners because this does seem to play a key role in how Trump approaches his economic agenda and some of the things we're seeing in D.C. Can you just explain this a bit for our listeners?

Michael Strain: Yeah, so there's a lot of evidence accumulated over decades and over a number of countries that periods of intense economic distress are followed by populist political movements. That narrative - what we saw in the Great Recession with extremely high rates of unemployment with local communities that were really decimated. That narrative that those economic factors fueled a sense of frustration and a sense of hopelessness that gave rise to Donald Trump on the political right and Bernie Sanders on the political left. That narrative is actually supported by really serious economics research. In addition to the Great Recession, if you just look over the last couple decades you see a lot of local communities that have been negatively impacted by globalization. You see significant advances in productivity in the manufacturing sector, but the flip side of that is the reality that you can graduate high school and not go to college, go get a job at the local manufacturing plant, and lead a middle-class life. That was an option available to everybody in the 1950's and 60's - no longer an option today in most manufacturing towns. This kind of disappearance of that path to the middle class have fueled what we saw culminated in the Great Recession. While that's been happening, there's been some serious developments on the social and cultural side as well. We've seen decade after decade of a decline in the institution of the family. An increase in the share of children born out of wedlock. An increase in the share of children who are not raised by two parents. We've seen increases in suicide rates. We now are all aware of the problem of opioid abuse and the toll that takes on individual lives and communities. So you've kind of had this toxic brew of economic change that has been slowly accumulating over decades, social change that has been slowly accumulating over decades and then the Great Recession, which was kind of the punch to the gut that happened at the end of it. That created a sense of frustration among many Americans. It created a sense of anger among many Americans and that manifested itself in support of populist politics and hostility towards immigrants in a desire to kind of close the United States off from the world. Concerns about international trade. We've seen a lot of that reflected in the 2016 presidential election and in how the President governed in 2017. The further away we get from the Great Recession, the better that situation will likely be. We'll see if 2018 is far enough away.

Nate Geraci: Well, Mike, with that as the backdrop, let's talk about tax reform. This was just signed into law right before the holidays and this was initially positioned as providing tax cuts to the people - to mainstream Americans - which was certainly something Trump campaigned on. I'll start with just a very broad question. Do you think the tax bill accomplishes that? That it helps mainstream America.

Michael Strain: Well, yes I do. If you look at the final bill that ended up being signed into law, something like 95% of households will see a reduction in the amount of income tax they owe. That's true for the next eight years let's say. Eight years from now a lot of these provisions start to expire. The question is whether the expired provisions will be extended. They probably will, they might not. Eight years is a long way away so I think, focusing on the next few years, it is the case that the overwhelming majority of American households will see a tax cut for themselves. A big part of this debate has also been a debate of who actually bears the burden of the corporate tax. Corporate taxes are levied on corporations, but how does that tax actually get paid? Does it get paid through a reduction of corporate profits? Does it get paid through a reduction of the wages that corporations pay to workers? Does it get paid through an increase in the prices that corporations charge for the goods and services they produce? That's an open question and a big part of the debate in that tax bill centered on that question. In my view, a big share of the burden of the corporate tax is born by the workers in the form of lower wages. I think that's a consensus view among economists. There's debate about how much of the corporate tax is born by workers. There's some smart and serious people who think it's 20%. There's smart and serious people who think it's 65% or 70%. But kind of somewhere between that one-third to two-thirds of the corporate tax is born by wages. That's where most economists find themselves. So when you reduce the corporate tax rate that should translate into an increase in wages. It should also translate into an increase in corporate investment, which will increase productivity and which will increase wages as well. My view is that not only will households see a tax cut, but they should also see some wage growth as a consequence of the tax bill as well. Now, that wage growth may take longer to materialize. The tax cut will materialize effective yesterday. The wage growth may take longer to materialize. In my view, it will eventually materialize.

Nate Geraci: It's interesting you mentioned that because we have already seen some headlines that companies like Fifth Third and Well Fargo are raising minimum wages. Other companies have promised bonuses - I think we've seen that from AT&T, Comcast, Sinclair - so it will be interesting to see if those stick and if they have meaningful staying power down the road. Our guest is Mike Strain, Director of Economic Policy Studies the American Enterprise Institute. Mike, I don't want to get too far into the weeds here, but two specific areas as it relates to the tax bill that I did want to be sure to touch on are housing and healthcare. At the individual taxpayer level, standard deductions were doubled so that could potentially limit the advantage of the mortgage interest deduction. Along with that the amount of mortgage debt you can now claim the interest deduction on was lowered and the deductibility of interest on home equity loans and lines of credit was eliminated altogether. Also, the deduction for state and local taxes including property taxes was capped at $10,000. Do you expect this to have any meaningful impact at all on the housing market?

Michael Strain: I don't think it will have a significant impact on the housing market. It is the case the share of people who itemize their deductions will go from say 30% to 10%. That's a significant reduction. As you said, mortgage interest is now capped at $750,000. So there are people for whom, on the margin, that will affect how much house they want to buy. It may even affect the decision to buy versus to rent. That should lower demand for housing, which should reduce the price of housing. So the question is how big of a price effect will that be? I don't think it'll be that big. The fact is that the overwhelming majority of homeowners don't itemize. That will still be true. It's also the case that $750,000 is a big, big mortgage in most parts of the country. For households that still do itemize, you can still afford to buy a really big house and write off your interest payments. I think there will be some effect, but just given the realities of the way that people pay their taxes and the realities of how much house most people buy I wouldn't expect the effect to be very big.

Nate Geraci: What about healthcare? Another aspect of the tax bill is that it removes the Affordable Care Act individual insurance mandate. There is some concern that might shrink the insurance pool and drive up premiums, which could cause more insurers to leave the market as a number already have. Any thoughts on this aspect of the tax bill? I know we could do an entire show on this, but any just high-level thoughts?

Michael Strain: This one will be interesting. There's been this debate for years over how effective the Affordable Care Act’s individual mandate has been as to getting people to actually buy health insurance. So there are a lot of things in the Affordable Care Act that get people to buy health insurance. One is subsidies to purchase health insurance. Another is this requirement that if you don't buy insurance then you have to pay a tax penalty as a consequence. The kind of official scorekeeper here in Washington for these debates, the Congressional Budget Office, had this view that 16 million people were getting health insurance because of the individual mandate. That played a large role in 2017's effort to repeal and replace the Affordable Care Act because Republicans want to get rid of the mandate and CBO says there will be 16 million people without insurance and then everybody freaks out and the bill fails. CBO recently lowered its estimate of the insurance impact of the individual mandate by more than 20%. They now say 13 million people will lose insurance. So that's the number you've heard bandied about as a consequence of the tax bill. The truth is that nobody knows. It is extremely difficult to produce any estimate of how many people are actually signing up for health insurance because of the mandate. My guess is that going from 16 million to 13 million is a step in the right direction. My guess is the actual number of people who are signing up because the government says if you don't sign up then you have to pay this tax is significantly less than 13 million. I suspect that eliminating the individual mandate will not have a large effect on the market for individual health insurance. Now, some other things might. There's a lot up in the air about the Affordable Care Act. There are a lot of things that the Trump administration can do without Congress in order to impact individual insurance markets. So it may be, depending on what the administration tries to do, it may be that 2018 is a tumultuous year in the individual health insurance market, but it won't be because of what Congress did with the individual mandate.

Nate Geraci: We're visiting with Mike Strain, Director of Economic Policy Studies at the American Enterprise Institute. Mike, we have just a few minutes left here and obviously, we can't talk tax cuts without talking deficit. Obviously, the tax cuts have to be paid for at some point. I think the hope from the Trump administration is growth from the economy will help draw greater tax revenues. But I've seen estimates that the tax plan will increase the deficit by around one trillion dollars. I've also seen that the national debt is expected to more than double over the next 30 years. What about the deficit side of the equation?

Michael Strain: I think it's a serious concern. I wish that Congress had been able to do a real tax reform that didn't impact the deficit where reductions in tax rates are financed by increasing the tax base. That is not what happened and I think that's lamentable. Deficits are a problem. Over the longer term, as the country accumulates more and more debt, that crowds out private investment which reduces wages and reduces income - which is exactly the opposite of what the tax bill is designed to do. The tax bill is designed to encourage investment and you have this big drag on investment in the form of higher deficits. Even worse things can happen if your debt gets too high. Then you start to be concerned about responding to catastrophes - the risk of a financial crisis, whether or not international bond markets think it’s credible that you can actually finance your debt without resorting to inflation which would drive up insurance even more. So all sorts of bad things could happen and it's a major, major weakness of the tax law that it increases the deficit so much. Having said that, it's important not to lose sight of the fact that the real driver of our long-term structural deficit is spending on entitlement programs - most notably Medicare, social security, and Medicaid. That's really what's driving our long-term deficits. That's a problem that needs to be solved. The tax bill made the deficit situation worse, but the damage over the next 30 years that Medicare's trajectory will inflict on the deficit is significantly worse than anything that happened in the tax bill.

Nate Geraci: Mike, we only have about two minutes left here. I did want to make sure to ask you about a potential infrastructure spending bill. The White House is expected to announce a proposed package later this month. This does seem to be an area where both Republicans and Democrats generally agree that we do need to upgrade our aging infrastructure. How do you expect this to play out since we are now in an election year and given the recent tax cuts and the growing deficit? Can you handicap this at all for us?

Michael Strain: Yeah, so there is agreement that infrastructure is a problem. What the President's going to propose in terms of paying for an infrastructure bill is going to look very different than what Democrats want. So even though there's an agreement on the problem, there's a lot of disagreement on the solution and, like you said, the clock is ticking until November. So we'll see how much legislating can actually get done.

Nate Geraci: Mike, with that, we'll have to leave it there. As always, just tremendous perspective on the economy. Thank you very much for joining us today.

Michael Strain: Yes, thanks for having me on and Happy New Year.

Nate Geraci: That was Mike Strain, Director of Economic Policy Studies at the American Enterprise Institute. You can read his work at aei.org and I would highly recommend following Mike on Twitter. His Twitter handle is @MichaelRStrain.