The Trump administration released its tax reform plan... sort of. Actually, the administration released the "core principles" of a plan that is admittedly still being worked out, and from the sound of it, there is a lot of work left to be done.
That's understandable. Major tax reform isn't something that will unfold easily.
The major risk to the stock market is that the passage of tax reform legislation doesn't unfold at all.
Tax Plan Cuts to the Core
Treasury Secretary Mnuchin and NEC Director Cohn presented the "core principles" of the plan that revolve around the following goals:
- Grow the economy and create millions of jobs
- Simplify the burdensome tax code
- Provide tax relief for American families - especially middle-income families
- Lower the business tax rate from one of the highest in the world to one of the lowest
The general framework sure does sound good on paper - literally. We're not sure if the administration was aiming to eliminate government waste specifically, yet it managed to summarize its tax reform initiatives on a one-page memo. The Sequoia National Forest sends its thanks.
In any event, the approach to tax reform covers a lot of constituents.
It creates three tax brackets for individuals (10%/25%/35%) versus the seven tax brackets that exist today; it calls for a business tax rate of 15%, a territorial tax system for businesses, and a one-time tax on overseas profits.
It involves a reduction in the top capital gains tax and dividend income rates to 20%, which includes the repeal of the 3.8% ACA tax.
This plan significantly reduces the number of tax deductions, including those for state and local taxes, while protecting the deductions for mortgage interest (a plus for the housing sector), charitable giving, and retirement savings. It also doubles the standard deduction taken for individuals and married couples filing jointly.
But, wait, there's more!
It also repeals the alternative minimum tax and the estate tax; and it seeks to eliminate tax breaks for special interests and targeted tax breaks that mainly benefit the wealthiest taxpayers.
For good measure, it was noted that the administration's intent is to get tax reform legislation passed before the end of the year.
The one thing the plan is lacking -- and this is why it could fit on one page -- is details.
The "details" are still being negotiated with House and Senate leadership, listeners were told by Mr. Mnuchin and Mr. Cohn, yet the administration's aim is to present those details at a later time when an agreement has been reached.
There is no more important detail than how tax reform gets paid for. It is evident that the Trump administration's approach to tax reform won't be deficit neutral.
Tax cuts for individuals and businesses mean the government will be receiving less tax revenue, which in turn means there will be less coming in to pay for everything that goes out for the government's mandated and discretionary spending programs.
The stock answer provided by Secretary Mnuchin is that the tax cuts will pay for themselves with increased growth (specifically sustained 3%+ GDP growth), the reduction in allowable tax deductions, and the closing of tax loopholes.
It is a specious assumption on several levels.
- First, the last time the U.S. economy achieved a sustained GDP growth rate of 3%+ was between 1996 and 2000 when it was experiencing the dot-com boom and robust consumer spending driven by healthy credit expansion and favorable demographics that had the bulk of baby boomers in their prime earning and spending years. That isn't the case anymore.
- Secondly, the federal government has rarely enjoyed a budget surplus over the course of the last 50 years, which has included some really good growth years along the way
- Third, higher interest rates come with growth, and with the elevated level of our federal debt today, the higher interest payments that will result from the higher interest rates will be a drag on growth as government resources get diverted to pay the increased interest on the debt
- Fourth -- and this may be the most relevant factor -- bad things like recessions, wars, natural disasters, and economically-damaging terrorist incidents happen to get in the way of the government's optimistic growth assumptions
What It All Means
The release of the core principles is a step in the right direction for the stock market, because at least it now knows the tax reform debate has been launched in an official manner.
The administration's plan sounds problematic from the start, though, given the known variable that it won't be deficit neutral at its birth, assuming this particular plan ended up being "the plan." It won't be.
The question is, how ugly will the sausage-making process get on the way to tax reform legislation, assuming Congress does get there? If past wrangling over the debt ceiling, the budget process, and the most recent effort to repeal and replace Obamacare are any indication, the sausage is apt to be spicy.
That will mean good things some days for the stock market and bad things other days, but lamentably, it may also mean a choppy, range-bound market for an extended period of time, absent some other unknown trigger.
Time and comments from Congressional leaders will eventually shed some important light on matters and the direction of the stock market, but for now, know that the tax reform effort is officially alive and kicking (and screaming) with the administration's core principles in play on the tax reform playing field.