US Budget: President’s high-wire act – BMO CM

Sal Guatieri, Senior Economist at BMO Capital Markets, notes that US President Trump released his 2018 Budget last week, and the biggest surprise is the virtual goose egg on the bottom line.

Key Quotes

“The deficit is projected to fall below $500 billion (or 2.2% of GDP) in 2020 before morphing into a small surplus in 2027. Accordingly, the federal debt drops to 60% of GDP in 2027 from 77% this year.”

“Trump’s plan to balance the books contrasts sharply with the Congressional Budget Office’s base-line forecast. Under current law and much different economic assumptions, the CBO projects the deficit will climb from $559 billion, or 2.9% of GDP, in 2017 to $1.4 trillion, or 5.0%, in 2027 (and then to 10% by 2047), lifting the federal debt to 89% (and 150%). Total spending is forecast to rise from 20.7% of GDP to 23.4% in 2027, largely in response to escalating Social Security and Medicare costs (which will consume nearly one of every two dollars spent by the government in 2027 due to an aging population).”

“Total revenue is projected to increase more slowly from 17.8% of GDP to 18.4% amid modest economic growth. Real GDP is assumed to expand just 1.9% on average through 2027 (only slightly better than potential of 1.8%) owing to a slow-growing labour force (0.6%) and moderate productivity gains (1.5%). In fact, the CBO’s estimate of the deficit this year might be too low based on recent figures.”

“Trump’s budget assumes real GDP increases 2.3% this year and 3.0% from 2021 to 2027. Growth averages 2.8% in the next decade, compared with the CBO’s 1.9% and the Blue Chip consensus’ 2.1%. By 2027, the economy is 11% larger than the CBO assumes.”

“Despite faster growth, Trump’s budget sees the jobless rate rising to 4.8% from 2021 to 2027. This is only slightly below the CBO’s view (4.9%) and close to the Fed’s estimate of the natural rate of unemployment (4.7%). As a result, inflation holds steady, keeping interest rates relatively low.”

“Though not zero, the odds of achieving 3% growth for six years are pretty low. True, real GDP did expand 3.0% on average in the past 60 years, and ran even well above this pace for consecutive years in the 1960s, 1980s and 1990s. However, the labour market is now operating at full employment. This means it will take more than demand-stoking tax cuts to boost growth. Supply will also need to increase to accommodate more demand.”

“Bottom Line: The President’s budget stands virtually no chance of becoming law.2 Democrats and moderate Republicans (many eying midterm elections) will push back at the hefty cuts to social programs. Fiscal hawks will question the over-reliance on faster economic growth to balance the books (no sure thing), as opposed to reining in escalating entitlement program costs (a sure thing given demographics). While the President’s recommendations will help shape budgets developed in the House and Senate, most of his proposals will be rejected, reducing the odds of a budget passing into law. In this event, Congress would need to pass continuing resolutions to keep parts of the government running next year. And, the fate of Trump’s tax cuts would be left up in the air.”