Debt Ceiling, Tax Policy and Trickle-Down Economics

by Deidra Krys-Rusoff
Senior Vice President

Market Wrap-Up

Global elections continued to stir up markets this week. U.S. stocks and the dollar initially rose as the British pound declined after the U.K.’s Conservative Party lost its parliamentary majority as the Brexit negotiations begin. Stock markets hit intraday highs, but trended downwards after a report on Apple noted that future iPhone modems could lag rivals’. The Dow Jones Industrial Average closed .33 percent higher than last Friday, the S&P index trended .27 percent lower and the Nasdaq Composite Index experienced a drop today, closing the week 1.53 percent lower than last Friday. The Treasury market closed out at slightly higher interest rates with the benchmark 10-year Treasury trading about 2.20 percent. Oil has slumped this week due to unexpected increases in the U.S. reserves, trading around $45.63 per barrel. Next week’s attention will shift to sovereign banks, as markets wait for an expected Federal Reserve interest rate increase along with results from Bank of England, Bank of Japan and Swiss National Bank meetings. 

Debt Ceiling and Tax Policy

The federal debt limit sounds restrictive – as if it is a way to rein in federal spending. In reality, it is an economic policy originally created in 1917 to allow the U.S. government an easier method to finance World War I and II. The debt ceiling has morphed from a simple financing tool to a political club, with battling factions wielding it in their fights for budget cuts and spending priorities. In 2011, the financial markets were roiled while Congress battled to raise the debt ceiling. To come to an agreement, they passed the Budget Control Act of 2011, which introduced sequestration and programmatic negotiations if a budget balance could not be decided. 

The United States hit its current debt limit of $19.8 trillion in March (a date determined in 2015 during a contentious bipartisan budget agreement). Despite hitting the current debt limit, the country has continued to pay its debts by employing “extraordinary measures” such as deferring retirement payments and shifting other funds. It was thought that these measures would allow Congress to delay a deal passage into the fall. However, Treasury Secretary Steven Mnuchin recently urged Congress to increase the debt ceiling before the August summer recess. Why the urgency? The Congressional Budget Office has determined that tax revenue is coming in at about 3 percent lower than expected. This may be attributed to taxpayers delaying investment gains while waiting for favorable tax reform. The Rockefeller Institute estimates wealthier individuals may have deferred recognizing up to 20 percent of their taxable income last year.

There is little doubt that the debt ceiling limit will be raised, but the timing could problematic for financial markets. Political turmoil may result in speculation about the U.S. ability to pay their debts, increasing market volatility. While both parties have suggested that the debt ceiling may be used for leverage, party leaders have acknowledged the need for a clean and decisive debt ceiling increase. Either way, it could be an interesting summer.

Trickle-down Economics Not Working in the Sunflower State

In 2012, Kansas narrowly passed a controversial tax bill eliminating an exemption for pass-through income and a bracket for high income tax payers. Governor Brownback introduced this legislation, which also included a “path to zero” plan to eventually eliminate income tax altogether.

The results of the tax cuts? Kansas collected about $1.2 billion less in revenue in 2016 than it had in 2013, while reducing spending by only $440 million and earning it a negative outlook from Moody’s rating agency. The Kansas Legislature voted Tuesday evening to end Governor Sam Brownback’s tax cut experiment in an overwhelming majority vote, overriding Brownback’s veto of the original round of legislation. The rollback is estimated to raise an additional $600 million per year. Moody’s upgraded the state’s outlook to stable following the vote.

Our Takeaways for the Week

  • U.S. stocks end the week near all-time highs, despite global political turmoil

  • U.S. debt ceiling negotiations are heating up and may impact financial markets

  • Kansas ends its trickle-down economics experiment

  • Attention shifts to next week sovereign bank meetings