Don’t confuse soaring stocks with real economic growth

It is difficult to cast 2017 as anything but a sensational year for the stock market. The S&P 500 rose in every month — the first time this has ever happened.

Volatility was lower than it’s ever been, on an annual basis, since we began keeping track 20 years ago. In addition, the market’s real return of around 18 percent is the 22nd-best since 1928 and the fourth best year since the turn of the century.

{mosads}Explaining why the stock market does what it does is largely a fool’s errand; a former colleague used to say that the only inference from a rising stock market was that there were more buyers than sellers. But as much as any time I can remember, the 2017 market was driven by a single piece of legislation: the promise of a large, deficit-funded tax cut.

Looking retroactively, the data seem to at least somewhat support this story. Through the first eight months of the year, when pundits and institutional investors were unsure if the Senate could overcome its razor-thin margin to pass a tax bill, monthly S&P growth was 1.1 percent.

But by September, it became clear that there would at least be a budget resolution, which in effect would allow Congress to pass a deficit-funded tax cut with only 50 votes in the Senate. A tax cut wasn’t locked in, but it seemed probable. For the remainder of the year, monthly stock market growth roughly doubled to 2.1 percent.

It’s hard to imagine a tax cut better designed to raise near-term stock prices. The crown jewel of the tax package —steep cuts in the corporate rate from 35 percent to 21 percent — will immediately add billions to corporate profitability, even without economic growth.

The Republican plan forgave hundreds of billions in owed taxes for multinational corporations who had deferred taxes in the past, which — judging by prior experience — will boost share buybacks and the attendant stock prices. The sheer magnitude of the package — with its $1.5-trillion price tag — is certain to boost consumer demand, at least a little, in the next year or two.

But market gains and economic growth are not at all the same thing. With the 2017 gains in the books, and the GOP tax plan signed into law, two questions are on the forefront: One, will the tax cut lead to more growth down the line? And two, is more stimulus coming?

The answer to the growth question can be answered by economic models. Congress’ Joint Committee on Taxation found that the bill would increase GDP by less than 1 percent, cumulatively, over the decade. The Wharton School’s Budget Model puts the annual growth rate from 2028 and 2040 at between 0.01 and 0.03 percent. All told, this is as close to zero extra growth as it gets.

Those who are looking for Congress to provide more stimulus in 2018 should be wary. The only real option here is an infrastructure package, and the odds are slim.

Here’s why: Republicans’ only real option for passing a major bill in 2018 is through the reconciliation process, which was used in the just-passed tax bill. (Reconciliation allows some bills to pass the Senate with 50 votes.)

Infrastructure spending would be an option, but the commonly suggested “pay-for” — using revenue from taxing the previously unpaid bills on foreign corporations — was just used to offset the corporate tax cuts. Republicans could use deficit spending, as they did with the tax cut, but many seem less inclined to borrow for spending than for tax breaks.

The challenges are not just procedural. There is real disagreement in the Republican ranks about how to improve our nation’s ailing infrastructure. During the campaign, then-candidate Trump wanted to do it with tax breaks for the private sector, while a substantial number of GOP senators appear to favor the old-fashioned way of simply paying for improvements. 

To sum up, was 2017 one of the best years ever for the market? No. Was it in the top quarter? Yes. Were market gains indicative of higher long-run growth? Probably not. Can we expect more fiscal stimulus in 2018? Only if you’re a true optimist.

Benjamin Harris is a visiting associate professor at the Kellogg School of Management at Northwestern University and was formerly the chief economist to Vice President Biden.