US tax cuts will fail as Trump’s demographic deficit replaces Reagan’s demographic dividend

No country in the world now has a top quality pension system.  That’s the conclusion from the latest Report by pensions consultants Melbourne Mercer.  As the chart above shows:

  • Denmark and The Netherlands have fallen out of the top category
  • In the G7 wealthy nations: Canada is in category B; Germany and UK in C+; France, US and Italy in C; Japan in D
  • In the BRICS emerging economies: Brazil is in category C; India, China and S Africa are D; and Russia’s system is so poor it is unclassified

Unsurprisingly, the cause of the problems is today’s ‘demographic deficit’, as the authors highlight:

“The provision of financial security in retirement is critical for both individuals and societies as most countries are now grappling with the social, economic and financial effects of ageing populations. The major causes of this demographic shift are declining birth rates and increasing longevity. Inevitably these developments are placing financial pressure on current retirement income systems. Indeed, the sustainability of some current systems is under threat.”

These problems have been building for years, as politicians have not wanted to have difficult conversations with voters over raising the retirement age.  Instead, they have preferred to ignore the issue, hoping that it will go away.

But, of course, problems that are ignored tend to get worse over time, rather than go away.  In the US, public pension funds saw their deficits jump $343bn last year to $3.85tn – making it almost certain that, eventually, pension benefits will have to be cut and taxes raised.

The issue has been that politicians preferred to believe central bank stimulus programmes could solve the deficit by cutting interest rates and printing large amounts of virtually free cash.  And unfortunately, when it became clear this policy was failing to work, the banks “doubled down” and pursued negative interest rates rather than admitting defeat:

  • Currently, 17% of all bonds (worth $8tn), trade at negative rates
  • Swiss bond yields are negative out to 2027, as the Pensions Partners chart shows
  • Most major European countries, and Japan, suffer from negative rates

2 years ago, Swiss pension experts suggested that its pension system would be bankrupt within 10 years, due to the requirement to pay retirees an annuity of 6.8% of their total savings each year.  This rate is clearly unaffordable with negative interest rates, unless the funds take massive risks with their capital.

The US faces similar problems with Social Security, which is the major source of income for most retirees.  The Trustees forecast its reserves will be depleted by 2034, when benefits will need to be cut by around a quarter.  Medicare funds for hospital and nursing will be depleted by 2029.  And as the Social Security Administration reports:

173 million workers are covered under Social Security.  46% of the workforce in private industry has no private pension coverage.  39% of workers report that they and/or their spouse have not personally saved any money for retirement.”

Rising life expectancy is a key part of the problem, as the World Economic Forum (WEF) reported in May.  Back in 1889, life expectancy was under 50 when Bismarck introduced the world’s first state pension in Germany.  Today, the average baby born in the G7 countries can expect to live to be 100.  As WEF conclude:

“One obvious implication of living longer is that we are going to have to spend longer working. The expectation that retirement will start early- to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy.” 

Sadly, politicians are still in denial, as President Trump’s proposed tax cuts confirm.

Today is not 1986, when President Reagan cut taxes in his October 1986 Tax Reform Act and was rewarded with higher tax revenues.  30 years ago, more and more BabyBoomers were entering the wealth creating 25 – 54 age group, as the chart from the Atlanta Fed confirms:

The issue is the ageing of the Boomers combined with the collapse of fertility rates:

  • The oldest Boomers left the Wealth Creator cohort in 2001, and the average Boomer (born in 1955) left in 2010
  • The relative number of Wealth Creators is also in decline, as US fertility rates have been below replacement level (2.1 babies/woman) for 45 years since 1970

Inevitably, therefore, Reagan’s demographic dividend has become Trump’s demographic deficit.

As I warned back in May, debt and demographics are set to destroy Trump’s growth dream.  And without immigration, the US working age population will fall by 18m by 2035, making a bad situation even worse.  Instead of tax cuts, Trump should instead be focused on 3 key priorities to:

  • Design measures to support older Boomers to stay in the workforce
  • Reverse the decline that has taken place in corporate funding for pensions
  • Tackle looming deficits in Social Security and Medicare”

Future retirees will not thank him for creating yet further debt headwinds by proposing unfunded tax cuts.  These might boost GDP in the short-term.  But they will certainly make it even more difficult to solve tomorrow’s pension deficits.

Trump’s healthcare focus risks postponement of tax reform and the infrastructure boost

US health cost Mar17President Trump ran for office on the basis that he would “drain the swamp” in Washington, and deliver major change in a number of critical areas, as I noted immediately after his election on 14 November.  Sensibly, his “Contract with America” also recognised that his Top 10 legislative priorities would take time to deliver:

“I will work with Congress to introduce the following broader legislative measures and fight for their passage within the first 100 days of my Administration:

1. Middle Class Tax Relief And Simplification Act.                 2. End The Offshoring Act. 
3. American Energy & Infrastructure Act.                             4. School Choice And Education Opportunity Act. 
5. Repeal and Replace Obamacare Act.                               6. Affordable Childcare and Eldercare Act. 
7. End Illegal Immigration Act.                                            8. Restoring Community Safety Act. 
9. Restoring National Security Act.                                    10. Clean up Corruption in Washington Act.

We are now more than halfway through his first 100 days, and already it is becoming clear that his priorities have been upended by House Republicans.  They have replaced Tax Reform at the top of their agenda with his 5th priority, Healthcare Reform, as the President confirmed earlier this month:

“Before we do the tax — which is actually very well finalized — but we can’t submit it until the health care statutorily or otherwise,” Trump told reporters before a White House budget meeting. “So we’re doing the health care — again moving along very well — sometime during the month of March, maybe mid-to-early March, we’ll be submitting something that I think people will be very impressed by.”

This is a potentially major setback for Trump’s agenda given that, at best, Congress is unlikely to agree on a healthcare bill before the summer.  This will mean he has lost 6 critical months in which to push forward on tax reform, his top priority. In turn, any progress on his 3rd priority, the $1tn infrastructure spending project, will have to wait until next year. As the conservative National Review has warned, this “is a polite way of saying it may not happen at all”.

The issue is simple.  As President Obama discovered in 2009, Congress can only handle one big initiative at a time.

Even though the Democrats also controlled both Houses, Obama was forced to choose between healthcare reform and climate change for his first term, and had to leave climate change for his second term.  President Trump may now be about to learn the same lesson, as he endeavours to pass both healthcare and tax reform. It seems he may have simply misjudged the complexity of the healthcare issue, as he told State Governors last month:

“Nobody knew that healthcare could be so complicated.  Everybody is different, every state is different, and different requirements, but I think we have something that’s going to really be excellent.”

The House currently hopes to agree its own draft healthcare bill within days.  But progress in the Senate – where Republicans hold only 52 of the 100 seats – may well be much slower.  One key issue is that US healthcare costs are already far more expensive than in Switzerland and other major countries, as the Wall Street Journal chart confirms:

□ It costs over a third more to deliver a normal baby in the US than in Switzerland, at nearly $11k
□ A routine knee replacement is also a third more expensive in the US at $28k
□ A heart bypass operation costs more than twice as much in the US at $78k
□ Compared to other advanced economies, US costs are even more out of line

Politically, the position is also likely to become more difficult. AARP, the powerful American Association of Retired People, has urged its 38 million members to oppose the House bill, calling it an “age tax” which would increase premiums by $13k/year for a 64-year old earning $24.5k/year:

“AARP recognizes the magnitude of the upcoming vote on this harmful legislation that creates an age tax, cuts the life of Medicare and gives sweetheart deals to big drug and insurance companies while doing nothing to lower the cost of health care or prescriptions”.

AARP’s move confirms a Foxnews poll showing only a third of voters currently support the House bill, and reinforces a warning from the non-political Congressional Budget Office that it ”would leave 24 million more Americans without health insurance“.  Similarly a Pew poll shows half of all Republicans earning less than $30k/year believe the government has a responsibility to ensure health coverage for all.

Unsurprisingly, therefore, 4 senior Republican senators have already signalled serious opposition to key parts of the Bill, due to its potential to strip people of Medicaid coverage. As they wrote to congressional leaders:

Unfortunately, the current version of the House bill…provides almost no new flexibility for states, does not ensure the resources necessary to make sure no one is left out, and shifts significant new costs to states.

Healthcare Mar17

Republican senator, John Boozman, has also highlighted a more fundamental issue:

“This is difficult—it’s 18% of the economy. My concern is not with the timeline; my concern is doing it right.

Boozman’s analysis is confirmed by the Our World in Data chart above, which shows:

 The US currently spends more on healthcare per person than any other country
 Since 1970, its spending has risen around 30-fold, from $300 to $9000 in 2014 (in $1970)
 Switzerland is the next-highest spender at $6750 per person – one third less than the US
 Yet average life expectancy is Switzerland is nearly 83 years compared to 79 years in the US

Life expectancy is, of course, not the only outcome by which to measure healthcare spending. But it is certainly highly important for most people. And as the study’s authors comment:

All countries in this graph have followed an upward trajectory (life expectancy increased as health expenditure increased), but the U.S. stands out as an exception following a much flatter trajectory; gains in life expectancy from additional health spending in the U.S. were much smaller than in the other high-income countries, particularly since the mid-1980s.”

It is still early days for the Trump administration, but it seems clear that healthcare reform is unlikely to proceed smoothly.  In turn, this makes it unlikely that Congress will pass both tax reform and infrastructure spending this year, disappointing many companies and investors.

Instead, they may well find that President Trump follows President Reagan in leaving tax reform until his second term. After all, even Reagan and his highly-skilled Treasury Secretary, James Baker, found that it took them 2 years to craft the necessary bi-partisan support in Congress that enabled his landmark reform to become law in 1986.


Political risk rises as Trump sets out to change America’s relationship with the world

Global markets are becoming ever more complex as the Great Reckoning for the failure of stimulus policies continues. This means that each blog post is now taking much longer to write. It therefore seems sensible to focus on writing 2 posts each week – on Monday and Thursday – in order to continue to provide the highest possible quality of analysis.

JFKIf you have a spare 2 minutes today, or later, you might like to view this extract from President Kennedy’s Inauguration speech on January 20, 1961.  The words are powerful in themselves, but the applause of the crowd as they warm to their new President makes it a very special address.

It marks the moment when America committed itself to be not only the land of the free, but also the defender of liberty around the world:

“We are the heirs of that first revolution. Let the word go forth from this time and place, to friend and foe alike, that the torch has been passed to a new generation of Americans–born in this century, tempered by war, disciplined by a hard and bitter peace, proud of our ancient heritage–and unwilling to witness or permit the slow undoing of those human rights to which this nation has always been committed, and to which we are committed today at home and around the world.

“Let every nation know, whether it wishes us well or ill, that we shall pay any price, bear any burden, meet any hardship, support any friend, oppose any foe to assure the survival and the success of liberty.

“This much we pledge–and more.

“To those old allies whose cultural and spiritual origins we share, we pledge the loyalty of faithful friends. United there is little we cannot do in a host of cooperative ventures. Divided there is little we can do–for we dare not meet a powerful challenge at odds and split asunder.”

It was a speech that transcended the political divide between Democrats and Republicans.  Here, for example, is President Reagan in front of the Brandenburg Gate in Berlin, West Germany, 26 years later, in 1987:


“Today I say: As long as this gate is closed, as long as this scar of a wall is permitted to stand, it is not the German question alone that remains open, but the question of freedom for all mankind.

“In the 1950s Khrushchev predicted: “We will bury you.”

“But in the West today, we see a free world that has achieved a level of prosperity and well-being unprecedented in all human history. In the Communist world, we see failure,

“There is one sign the Soviets can make that would be unmistakable, that would advance dramatically the cause of freedom and peace.

“General Secretary Gorbachev, if you seek peace, if you seek prosperity for the Soviet Union and Eastern Europe, if you seek liberalization: Come here to this gate.

“Mr. Gorbachev, open this gate.

“Mr. Gorbachev — Mr. Gorbachev, tear down this wall!”

In less than 3 weeks time, on January 20, a new President will deliver his Inauguration speech at the same podium where Kennedy, Reagan and other past Presidents spoke.  From what we know today, it is likely that President Trump will, however, deliver a very different message.  His pre-Election speech at Gettysburg talked of building a wall, not tearing one down.  And he made no commitment to maintain America’s leadership of the free world.

If President Trump pursues the policy program on which he was elected, we are therefore about to live through a paradigm shift in America’s role in the world.  This is his right as President, and America’s right as a free country.  But it is critical that all of us recognise the change about to take place.

This is not a minor development.  In its own way, it could prove as long-lasting a shift as JFK’s manifesto.

None of us have any experience of political risk on this scale.  Since Kennedy’s speech, the US has seen itself as the world’s policeman.  Now, this bedrock of our lives – whether we live in the USA or elsewhere – may be about to change.  It may lead us to a better future, or it may not.  None of us, not even President Trump, can be sure.

Human beings hate change.  But after January 20, Denial will no longer be an option.  There will be Winners and Losers.  In 2017, the Winners in today’s New Normal world will be those who recognise that managing political and social risks has become critical to achieving economic success.