With a slow week for data, we thought we would begin to discuss the potential consequences of proposed Trump policies. Our goal here is not to critique new policies, but to ruminate about their potential effects on inflation and growth – and what guideposts to look for in determining whether our expectations are correct. As many policy proposals are not yet completely clear, this will be a broad brush look at immigration reform, tariffs, deregulation, and taxes.

First off, we note that 75-80% of what we read on how Trump’s policies will affect the economy start with the caveat that he is really establishing a negotiating position – and that the ultimate result will be more in line with the writers’ own wishes and desires. (Note a recent Reuter’s survey of economists expecting just 40% tariffs.) We assume that Trump is asking for what he wants – and expects — given he won the popular vote and his party controls both chambers of Congress. Pundits and markets have been continually surprised by the significant changes proposed by President Trump – and by his ability to pass them, like lowering the corporate tax rate to 21%, not the 25-26% most expected. Bottom line, we take the President-elects’ starting points as very likely to be the outcomes – at least, that’s the way to bet.

Second, we note that most analysis focuses on one policy – and primarily on the negative aspects. Obviously, the Trump Administration sees positives from all – but more importantly from the mix. Lower taxes and deregulation are expected to grow the economic pie, while tariffs and immigration reform focus the winnings on American firms and workers. Whether reality is as effective as in campaign promises is what we will be writing about for the next four years.

Noting that Trump’s earliest Administration picks were focused on immigration we begin there. He has promised more aggressive deportations on day one, which means the immediate reversal of several Biden Administration executive orders and reinstatement of those prevailing under the first Trump Administration. Trump has said that no illegal immigrant is safe. It was estimated that there were 11 million illegals in the US pre-Covid – a number that had been stable for many years. Illegals swelled under the Biden Administration, as reflected by the 3.7 million backlog of removal orders in the courts. If we assume 15 million illegals that is about 4.5% of the population of the US.

How many can be quickly removed? In the year ended June 2024 (after Title 42 ended in May 2023), the Biden Administration removed 842,000 illegals – though 2/3rds were at the border, mostly under rules allowing release and expulsion without arrest. During the Obama Administration and under Trump in the year pre-Covid, deportations – meaning ICE arrests and removals through the courts – ran at roughly 400,000 a year. Returns at the border added about half that much. Note that during this period, the estimated number of remaining illegals did not fall. Moreover, the unemployment rate was falling steadily, unlike recently when part of its rise has been blamed on the flood of illegals.

Exit polls note that Trump won many more votes from Latinos – in our view, because they were the population most effected by the influx of illegals. The sharp increase in competing labor depressed wages and raised rents for this group, making many worse off than under Trump’s first term (never mind the Covid money) – and they voted their pocketbooks. Correspondingly, this group should see the greatest and quickest improvement in living standards as immigration rules stiffen. So, we will watch wages in industries like construction, agriculture, and leisure & hospitality — plus rents, particularly in the Southwest — for signs the policy is having an effect. Similarly, retail sales and homebuilding in this region will illuminate positive and negative effects that may be amplified to the national level.

The surge in immigration under Biden added not only to the number of illegals, but also to total employment and real GDP. We estimate that 0.5% of the rise in real GDP in recent years was due to immigration, trimming performance over the past ten quarters from 2.9% to 2.4%. US Growth averaged 2.4% from the fourth quarter of 2010 through the fourth quarter of 2019. Bottom line, we start with a 2.4% growth estimate under Trump assuming an immigration policy as tough as during his first term. A tougher policy would more restrictive to aggregate growth, though it should benefit per capita income for lower income workers, as during Covid when labor markets tightened. We find it unlikely that ICE can deport enough illegals to reduce total available labor more than 0.5% a year without a significant pushback from those sectors where the hit would be concentrated. Bottom line, we feel the US economy is currently strong enough to absorb tighter immigration policy on its own. The question is what happens when other policies are shifting as well.

Next on our list is tariffs. Trump has promised at least 60% on China and 10% on everyone else. In the second half of his first term (as estimated by the Tax Foundation), he imposed $79 billion in tariffs on $380 billion of goods (an average 21% tax) – mostly on China. Biden kept most of those tariffs and added modestly this year with tariffs on semiconductors. The Foundation estimates the long run cost at 0.2% of GDP (one time, not per year), 142,000 jobs (roughly 0.1%), and 0.1% of capital stock. Given the new taxes amounted to 0.3% of GDP, and taxes lost on the -0.2% of GDP would be at roughly a 18% rate, tariffs added modestly to tax revenue with a negligible hit to the economy. The new tariffs if applied across the board would raise $700 billion — $360 billion on China ($600 billion @ 60%) and $340 billion elsewhere at 10% – assuming no shifts in behavior, which will happen. The Tax Foundation estimates $524 billion in new taxes annually, with GDP hit by 0.8%, capital stock by 0.7% and jobs by 0.5% — or roughly 4 to 7 times the effect of the 2018 tariffs. Many estimates we have seen expect $300 billion more taxes in 2025, or about 1% of GDP, after retaliation and offsets. That is 15% of what Elon Musk is seeking to save from new government efficiency.

At first blush, both more restrictive immigration and a tax hike via tariffs should weigh on the US economy. Yet, even both at the same time might not sink the economy, especially if there are positive offsets from lower taxes and weaker regulation. The outcome of this mélange of positives and negatives is tricky to predict. Timing, and the intervention of other events — like an oil shock, war, peace or disease — can produce diverse results. Our main insight on the drags from tariffs and immigration is that their effect may not derail the aggregate economy as many expect – especially if the Administration is nimble in responding to pushback. Specific industries and regions may be heavily impacted, but that does not mean a slump in overall growth. Note, the US has been wallowing through a manufacturing recession for the past two years, but real growth has still handily outperformed potential due to the strength in services.

We would also be cautious about jumping to the conclusion that tariffs will generate significantly higher inflation. The estimated $300 billion noted above would represent a tax of 1% of GDP – but spread over what period of time? Tariffs increase the price of those things tariffed and lower the relative cost of those things that are not – like US made goods and US services – which is the whole point. If exclusions are granted for those goods where locals have greater difficulty avoiding the tax or shifting its burden, the effect on measured prices will be mitigated. Moreover, just because a tax is levied does not mean that the Federal Reserve will ease policy enough to allow it to be absorbed via inflation. Indeed, the FOMC is in exactly the opposite stance now, becoming cautious as inflation and the economy have not slowed as much as expected. As long as Powell is in office, we do not see them funding Trump’s tariffs.

That means tariffs will act as a drag on the economy, as consumers are forced to decide between purchases of now more expensive tariffed items and other goods and services. Will other prices also be rising because of tighter labor markets due to immigration reform? Will the incomes of lower income households, who spend at least 100% of their earnings, outstrip inflation as tariffs and immigration reform favor US labor? A further loss of real spending power would undermine Trump’s chances of maintaining control of the House at the mid-terms. Flexibility will be critical to maintaining the narrative that tariffs and immigration reform are beneficial. We will be watching nominal GDP — which should remain near 5% on the Fed’s current path. At that level, there is room for a modest rise in inflation (sold as temporary due to one-time tariffs) with slowing real growth still above or near potential.

Managing the details of inflation is critical to the US virtuous cycle. We have noted many times that deflation in goods prices is currently deeper than pre-Covid – due to cheap energy and a strong dollar. More goods deflation has allowed US service providers to raise prices more than pre-Covid — and so pay higher wages, sustaining consumer buying power. Less goods deflation due to tariffs or immigration reform may limit future service inflation as competition for consumer’s buying power trims price hikes – again mitigating the expected rise in the CPI or PCE deflator. The big question is whether helping lower income Americans and simultaneously limiting inflation will eat into profit margins.

The two campaign promises that investors are applauding are deregulation and lower taxes. Both are expected to enhance productivity and profits – allowing greater investment in new technologies that lift potential growth. Not surprisingly, capitalists, who tend to favor the invisible hand, are more enamored of calls for less government involvement in their decision making than in protection from competition via tariffs. Bottom line, a bigger pie feeds everyone.

Campaign promises come in all sizes, as reflected in the Tax Foundation’s estimates on three Trump’s stump staples: no tax on tips (defining tips as how most do now) would cost $100 billion over ten years; a 15% tax on corporations would cost $250 billion over that period; but eliminating taxes on social security income would be a heftier $1.6 trillion. Extending the existing Trump tax regime is widely assumed, so we see no price or economic effect from that near term. We see cutting taxes on tips and corporations as a low-cost way to reward key constituencies, and should pass easily.

With respect to tax hikes, deficits spending and government efficiency, it is critical to understand that the federal government is different than private businesses due to its scale and the scope of the feedback mechanism. For example, the income freed by $10 billion a year in lower taxes on tips would likely all be spent – with governments of all stripes getting back roughly 18% via taxes. The same tax feedback loop occurs when the federal government runs a deficit to inject the money into the economy, whether via transfers or other spending. Conversely, when private companies raise wages, cut prices, or spend borrowed money, they cannot expect much to find its way back to their firm.

Also, when Elon Musk cut employment at Twitter, he saved a lot of money. However, if laid off federal government employees do not find new jobs, they often go on government income support programs – especially for health care. Moreover, any reduction in income they suffer reduces tax receipts by that 18%. Critics have argued that excess government employment is a form of workfare, with cities, states and the federal government substituting earned income for transfers. Bottom line, the tax feedback loop has long incentivized spending and limited deficit reduction. Every proposed program is supported by a study that shows the hefty benefits in auxiliary jobs created and taxes earned. We expect that significant savings will be difficult to realize – and likely not very quickly.

Lowering the corporate tax rate to 15% may have a number of consequences concerning how firms structure themselves– and where! With the top marginal rates for individuals well above 15%, some business may restructure pass-through arrangements, like S-corporations or partnerships. Much of this already happened with the 2018 law, but some smaller firms may shift at the lower rate. More interesting is the question of where income will be realized and taxed. Some tax havens, like Ireland, are resetting their base rate to 15% in line with the EU. It also seems likely that some firms will want to increase their domestic presence for appearance and lobbying strength. The lower the cost of paying in the US and the higher the penalty – financial or otherwise – for not putting America First, the more shifting we could see. Where money is officially earned and held can affect investments, and employment in jobs, like finance, legal and accounting.

The yardsticks that both investors and the Administration will use to measure success are the S&P500 and long-term rates. Equities have already priced in an optimistic outlook. Risktakers always see the upside. Meanwhile, fixed income is worried about both inflation and deficits. Still at 4.4% on a ten-year note, we do not believe rates are restricting an economy running at 5% nominal growth. Change is the real signal, so we will be monitoring movements closely.

One measure where Trump may differ from the markets is the dollar. Here we will critique his policy. True, if maximizing production is your goal, a strong currency hurts. However, a stronger dollar reflects inflows of capital as global investors vote that the US is the best economy, and want part of its ownership and control of global production. As it strengthens, every American is being given more buying power for imports, and freed income to support domestic spending.

We see the US as the suburbs of the world – which has exported its manufacturing sector as its workers climbed the job skill ladder. The major issue with China is not that they run a trade surplus, but rather that they seek to control more of production – including that owned by multinational firms. To us, this is more like a fight between a firm and its union than a new cold war between rivals with non-intersecting trade blocs. To win, the bosses need to find new sources of labor – hopefully cheaper, but clearly with fewer demands. That calls for differential tariffs to punish China while rewarding new trade partners. As Europe is unlikely to replace Chinese production, tariffs on them are a different issue. However, tariffs on Vietnam, India or Mexico would only slow the shift in production from China. Better to weaken China’s direct influence – even if the new sources include some Chinese participation. Moreover, winnings should be used to enhance US multinational’s ability to compete globally (lower taxes are a start) to help expand US political and economic control of the global economy. In the suburbs, asset appreciation is the key to success, not income growth.