The Ratchet and the Sausage Machine
The Purist and the Pragmatist fall out but are essentially after the same thing
US Government Bills are like sausages, the more you look into their components and the process of manufacturing, the more unpleasant they seem. It strikes us that this is a key part of the row between the twin Kings of Social Media – Musk and Trump – both of whom took to their respective networks to openly disagree in public last week.
Trump the deal maker has learned the hard way that, to use arch Politician Tony Blair’s favourite phrase, “ Politics is the art of the possible”. Anyone who has seen the television series House of Cards will recognise the compromises and political wrangling needed to pass a Bill in the House. Trump’s Big Beautiful Bill (BBB) was primarily about preventing the sunsetting of the tax cuts that he passed in his previous term and thus was not so much about cutting taxes as preventing them rising.
The Bill was primarily about preventing previous tax cuts from expiring
Had it failed, it would have triggered politically unpopular tax increases and likely a sharp slowdown in the economy, which would have been seized on with delight by his (many) political enemies as a failure leading to bad economic outcomes. As such he needed to make the necessary compromises to get it passed -i.e. pack it out with the ‘pork’ on which US Politics thrives but which the purist Musk despises.
The reality is that a key part of DOGE was to highlight to Congress and the public just how much waste, corruption and ‘fat’ there is in the system in order to make the case for the BBB. The very purist nature of Elon Musk that is now leading to the disagreement is exactly the reason why he was the ideal figurehead for the DOGE project in the first place.
Elon Musk’s role was to support the case for keeping previous tax cuts by demonstrating the capacity for cutting spending
The areas that Trump has so far focused on and already moved to cut by Executive Order were the ones that were also politically important, in so far as they funded his enemies, especially those in the ‘deep state’. The rest have to go through the House and as such are likely a key part of the Mid Term playbook; use the DOGE discoveries to undermine Democrat politicians where you can. Don’t make cuts by executive order, force the opposition to defend the wasteful spending.
We don’t think this is a ‘cunning plan’ to stop left wing activists attacking Elon Musk and his companies, although it is a helpful side effect, but is usefully highlights the spending incontinence of US politics and the ratchet effect of every year more spending is added and none is taken away.
Another important point is that the BBB was not actually a traditional spending bill in so far as it did not deal much with discretionary spending – which in any event is only around a third of the total Budget (of which the Pentagon takes up around a third of that). Also worth noting that there is slight of hand (on both sides) with numbers, some of which are quoted annually and others over 10 years, depending on how you want to spin the narrative.
The proposed cuts to mandatory items like Medicaid and Social Security, which were too much for some and not enough for others, also need to be put into context. Here I am grateful for the insights from the team at the All in Pod podcast (well worth listening to) who pointed out that even after these terrible/insufficient cuts, such was the splurge during and after Covid, that Medicaid and Social Security are still significantly higher than in 2019.
Incidentally part of the value (to me) of the All In Pod is that we hear some of the information that is clearly going to Team Trump (as well as coming from them) and is the basis of the decisions being made. The reality is that Team Trum pare not listening to the editorials of the FT or the NYT and anyone wanting to try and work out what they will do, rather than what someone thinks they should do needs to take this into account.
This is the ratchet effect that behavioural scientists refer to as ‘anchoring’, the implicit assumption that the status quo is somehow the correct starting point. This of course is something that Team Trump are very aware of with their plan to take everyone earning less than $150k a year out of Federal Income Tax altogether. Should they succeed in raising $600bn a year (which is an average of 15-20% on the $3-$4trn of imports) then far from being a net increase in tax on US consumers (as implied by many of the economic models), it would instead be a mix of consumption and corporate tax increases on the one hand (some on Foreign companies but a lot on US multinationals avoiding tax through transfer pricing) and balancing tax cuts to 90% of the population.
The tariffs are part of an overall package to shift the burden of taxation from income to a mix of consumption and corporation taxes.
As such, this policy would be highly radical and likely stimulatory, since we know from not only the models but also the recent experience of Covid cheques, that the propensity to consume at this end of the economy is far higher. As such the initial tax take might be the same as the tax cut, but the stimulus to the economy would work to deliver nominal GDP > interest rates, producing second round effects allowing for the US to grow, rather than inflate, its way out of debt.
Interesting (and also from the All In Pod) the Congressional Budget office assumptions on growth that lie behind the gloomy projections on the deficit are down at 1.7%. At the very least, we should see a range of assumptions so as to ascertain the range of possible outcomes for Debt and the deficit and the role that GDP growth rather than just spending cuts can play.
In addition, the ratchet effect would be such that any possible future Democrat government could be painted as a return to tax and spend – a tactic that helped keep Labour out of power for almost 20 years and one that deeper thinking Democrats are doubtless well aware of.
As to the markets (and a reminder that none of this is to be considered investment advice), it seems to us that the Team Trump policy is actually to usher foreign investors, especially Sovereign Wealth Funds, out of the listed equity markets, with the slack being taken up by US Retail and especially long term savings products like 401ks – on the basis that $5trn of assets where 100m people own $50,000 each is better than 50,000 people owning $100m each. Of course, the 50,000 would disagree and, currently, their voices are louder than the 100m who would agree (money talks and all that).
Hidden within the thousand page bill was Section 899, which allows the US to effectively tax the returns foreigners get from owning US securities if their own regimes are deemed unfair to the US. There is no real hard detail and of course there is now intensive lobbying but the revelation alone (the discovery of which was no doubt helped by AI) is likely to be enough to prompt further diversification by overseas investors.
The key question is where is China going to recycle its dollars?
The SWFs meanwhile might wish to invest directly into US infrastructure, factories etc (as implied from Trump’s Middle East tour, but the biggest earner of US$, China, is not even going to be allowed to do that. How and where the China US$ get spent is going to be key for market trends.