Trump adviser Hassett talks up tax law and stock market ahead of State of the Union

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Council of Economic Advisers Chairman Kevin Hassett

Americans will understand that the effects of the tax law signed by President Donald Trump aren’t “fictional,” and that it’s working as intended, a top White House official told MarketWatch a day before Trump is due to promote his policies in his first State of the Union address.

Kevin Hassett, the chairman of the Council of Economic Advisers, spoke to MarketWatch about Trump’s plans to rebuild U.S. roads and bridges; how the president will add “color” in his speech to his trade ideas; and the implications of the sweeping tax law.

“The tax bill is going to have a big, positive effect on the economy,” Hassett said in a phone interview, “and once people see it in their paychecks, then they’re going to understand, I think, that the effects are not fictional.”

Hassett, formerly an economist at the American Enterprise Institute, also commented on stock valuations and said optimism about the U.S. economy “should be something that’s reflected in the markets” going forward.

Here is a lightly edited and condensed transcript of the interview.

MarketWatch: In last year’s speech before a joint session of Congress, the president used it to push an infrastructure program — which still hasn’t happened. He’s going to use this year’s speech to promote infrastructure, too. But why should businesses have more confidence this time, this year?

Hassett: Well, the president will talk about his trillion-dollar plan for rebuilding our infrastructure, and I think that people of both parties agree that the nation’s infrastructure is in decay and that it’s not serving us well and needs to be improved.

I think that historically, infrastructure-type bills have done OK even in election years because there is such broad bipartisan support for infrastructure. And so last year, I think the president was right to prioritize taxes. If you look at accomplishments, it was historic. And if you look at the way the economy and markets are responding to the tax bill, I think that you can judge that the president’s judgment was correct, that moving taxes first was a good idea.

Ideally taxes would have passed in March and we could have done infrastructure last year, too. But there’s only so much legislative time in the calendar, and I think that turning to infrastructure now is a very sound idea economically — I mean, it’s still something that needs to be fixed. Politically I think that there should be the floor time to do it.

MarketWatch: What we’ve seen leaked out on the infrastructure plan is that it’s a matching fund, and contingent on either local government or private funding of the same projects. So, how much of the roughly $200 billion set aside would actually be used?

Hassett: I think that I’m not supposed to respond to comments about leaked documents, and I’m not even sure that the leaked document is accurate or up to date, and so I think that the best thing is to wait and see what the president says in the State of the Union.

MarketWatch: He is expected to promote the tax law in the speech. But at least one recent poll found that just 29% of Americans see it as mostly positive for their family. Why do you think the law isn’t more popular?

Hassett: I think that the law is going to have a big, positive effect on the economy, that that positive effect is visible already if you look at the millions of people that have had pay raises, the hundreds of businesses that have said that they plan to move plants back to the U.S., and so on.

Ultimately, the academic literature suggests that Americans respond in the voting booth to how the economy is doing, and they hold the party that’s in power accountable for the state of the economy. That’s a calculus that we’re very happy to have them make, because the tax bill is going to have a big, positive effect on the economy and once people see it in their paychecks, then they’re going to understand, I think, that the effects are not fictional; that they were scientifically based from the beginning, and that they’re working as designed — or as intended, maybe is a better way to say it.

See: Mnuchin says 90% of workers will get more take-home pay under withholding change.

MarketWatch: In his Davos speech last week, the president said that trade needs to be fair and reciprocal. What more in the State of the Union will we hear about that, and why won’t this approach result in a trade war?

Hassett: I think you’re right, that the president is once again going to add color to the idea of what fair and reciprocal trade looks like. I think this is something in both the APEC speech and the Davos speech that he’s begun to flesh out.

I think that the president’s exactly right, that if you look at many of the trade deals that America’s signed over time, that we’ve tended to agree to things that were quite asymmetric: allowing other countries to have high tariffs on our things while we remove all tariffs on theirs.

I think that everybody in the Trump administration believes in free trade. The problem is that for some of our deals, it looks like that belief is one-sided. The president had a life of success at negotiating, and his intent is to do a better job than previous presidents have at negotiating fair and reciprocal deals. Who would bet against him, given his track record in terms of negotiations?

MarketWatch: The president has highlighted the strength of the economy, at a time when the trade deficit has widened substantially. Economists say one impact of the tax bill will be to worsen the trade deficit even further. So doesn’t this show somehow that the administration is wrong to link the trade balance to economic performance?

Hassett: There are going to be times when we decide to import more of something for reasons that are sound economically. I think the problem in the president’s mind arises when there are clear, sort of, asymmetries in trade deals that disadvantage American firms, and those are the kind of things that he wants to fix.

In terms of the tax bill, I disagree that one should expect the tax bill to increase the trade deficit. There are a number of effects that it might have on it, but I think that the biggest effect is that right now, about 51% — according to a CEA estimate — of the trade deficit is attributable to transfer pricing by U.S. multinationals, who make products, say, in Ireland and ship them back to the U.S., rather than making them here. They established that practice because we were the high-tax place on earth, and they could avoid U.S. tax by locating activity offshore.

The tax bill has carrots and sticks designed to encourage firms to stop doing that, and given that that behavior accounts for 50% of the trade deficit — that is, the trade deficit is twice as high as it would be if U.S. multinationals weren’t doing this — then any reduction in that activity is very much first order in terms of the trade deficit, and it would reduce it.

MarketWatch: The president has frequently discussed the record highs of the stock market. Now that tax reform has passed, do you think that there’s much more room to go? And are you concerned at all about valuations?

Hassett: I think that one way to think about the movements last year in equity markets is that it’s the after-tax cash flow in present value that matters when you’re valuing equities. And in the old world, firms got to keep say, after tax, 65% of their profit. And now in the new world, they’ll get to keep 79% of their profit. So if you go from a .65 to a .79 out in front of a value formula, you can get a big stock market increase, which is I think something that we experienced last year.

I think going forward, that valuations will continue to be sound, provided that earnings and growth continue to hold up, and I think there’s every reason to expect that they will, given that we’ve just gone from the least competitive tax situation in the developed world to one that’s much more competitive. So there’s a lot of reason to be optimistic about the American economy, and that should be something that’s reflected in markets as well.

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