Tags: Donald Trump | Trump Tax Reform | Michael Lewitt | Donald Trump | Steven Mnuchin | tax cuts

Michael Lewitt: Crushing Debt Will Stifle Growth Despite Tax Cuts

Michael Lewitt: Crushing Debt Will Stifle Growth Despite Tax Cuts
(Dreamstime)

By    |   Tuesday, 02 May 2017 11:57 AM

Michael Lewitt, the manager of the Third Friday Total Return Fund who has warned that stocks are in a bubble, said the global economy is groaning under massive debts that have built up since the 2008 financial crisis, and tax cuts proposed by President Donald Trump won’t necessarily boost growth.

“A heavy debt load suppresses growth and … much of the meager growth experienced since the financial crisis was fueled by an epic accumulation of public and private sector debt,” Lewitt said in the May issue of his Credit Strategist newsletter. “Divorcing economic growth from debt growth paints a false picture of what occurred in the American economy since the financial crisis and offers false hope for the type of growth that can be achieved unless there is a radical reordering of budget and tax priorities in the future.”

U.S. Treasury Secretary Steven Mnuchin this week said economic growth of 3 percent is achievable in the next two years as the Trump administration seeks tax cuts to create more incentives to work and invest. The U.S. economy has grown by 3.2 percent a year on average since 1947, but never exceeded 3 percent during the Obama administration, the first time in history.

Lewitt cites data that show total U.S. debt, including nonfinancial, foreign and bank debt, reached 372.5 percent of gross domestic product last year, compared with 251.9 percent in 2006, the last time the Federal Reserve started a rate-hiking cycle.

The debt data show “one of two things: the economy (and markets) are going to take a big hit if rates normalize or – more likely – rates are not going to rise very much because the economy (and markets) won’t be able to take the pain,” Lewitt said.

Debt-Fueled Growth

The Fed in March raised interest rates for the third time in the past 10 years with the prospect that Trump would push for a fiscal plan to stimulate stronger growth. Prior to its December 2015 hike, the central bank had held rates at record lows near zero percent since 2008, when the global economy suffered its worst decline since the Great Depression.

The Fed typically raises interest rates when the economy shows signs of overheating, as indicated by rising inflation. U.S. GDP grew 0.7 percent during the first quarter from a year earlier, the weakest in three years as consumer spending slowed.

Surveys of Wall Street economists show that they expect the central bank to hike rates this year two more times by 0.25 percentage point each.

Lewitt is concerned that the Fed is making borrowing costs more expensive for governments, businesses and consumers at a time when debt levels have jumped. Business debt increased to 72.6 percent of GDP in 2016 from a prior peak of 70.2 percent in 2009.

“U.S. corporate debt is much higher today than on the cusp of the financial crisis in 2007; it just doesn’t feel that way because low rates disguise the high level of debt,” Lewitt said. “Corporate America’s balance sheet is heavily leveraged and highly vulnerable to rising rates. The Fed is aware of this and likely to shy away from aggressive action as a result.”

Three Principals for Tax Reform

Lewitt said tax reform should be based on three principals that would help to strengthen the U.S. economy:

  1. elimination of the tax incentives for debt (i.e. eliminating the tax deduction for interest payments)
  2. equal taxation of capital and labor (i.e. eliminating the capital gains tax)
  3. lower rates and elimination of most deductions to simplify the tax code and remove the government from the markets

“The first principal is the most important in addressing America’s debt crisis: until we stop creating incentives that favor debt over equity, we will have a debt-based economy whose growth will be limited by the amount of financial and intellectual capital devoted to debt service,” Lewitt said. “If we rebuild the tax code from these principles, we can set the economy on a much more productive and stable course.”

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Michael Lewitt, the manager of the Third Friday Total Return Fund who has warned that stocks are in a bubble, said the global economy is groaning under massive debts that have built up since the 2008 financial crisis, and tax cuts proposed by President Donald Trump won't...
Michael Lewitt, Donald Trump, Steven Mnuchin, tax cuts
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2017-57-02
Tuesday, 02 May 2017 11:57 AM
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