Trump Releases Tax Plan

If tax season's conclusion on April 18 left you feeling a little lost, perhaps wishing tax matters could remain front and center in the national conversation a while longer, Wednesday must have been a relief. Top administration officials took to the podium to announce "a once-in-a-generation opportunity to do something really big" with tax policy, and the media went wild with breakdowns, analyst roundups, predictions and opinions pro and con. While we understand the excitement, in our view, all this hoopla makes too much of a loosely sketched proposal with an uncertain future-and one that isn't inherently bullish (or bearish) for the economy and stocks.

First, let's get the details-and the caveats.

• The plan trims individual tax brackets from seven to three: 35%, 25% and 10%. Simpler may be better, but income thresholds aren't specified, so taxpayer savings aren't certain. Then too, most deductions-including for state and local taxes-would vanish, leaving only the standard deduction (which would double) and those for retirement saving, mortgage interest and charitable giving.
• Other proposed individual tax changes include scrapping the estate tax, alternative minimum tax and 3.8% Obamacare tax on certain investment income. There is also a childcare tax break, but no word yet on its size or eligibility requirements.
• On the business side, the headline corporate tax rate would fall from 35% to 15%. "Pass-through" businesses (including many small firms) whose profits are taxed at the owners' income tax rates would also pay 15%, down from a 39.6% peak. The shift would end decades of frustration over an uneven playing field between big and small businesses (and possibly spur a boom in "LLCs").
• While 35 to 15 may sound like a drastic cut, just a few large corporations pay the highest rate presently, as exemptions abound. These exemptions may also be on the chopping block: Policymakers generally favor simplifying the tax code over reducing corporations' tax burden, so it seems fair to presume the plan will seek to close most loopholes. Hence, it's unclear how much/whether corporate taxes would decrease overall-though simplifying would at least cut tax prep costs.
• Also freeing up resources, corporations would no longer pay taxes on overseas profits, excepting a one-time "repatriation" tax on existing earnings they bring back to the US. Continuing a pattern, the repatriation tax's size is to be determined, but officials have hinted it'll be 10%. Whether or not this jolts business investment in the US, easing moving money around the world would be a positive.
• Another positive: The border adjustment tax-a 20% import levy Congressional Republicans have proposed-isn't included. Treasury Secretary Steve Mnuchin called it "unworkable" as envisioned by Congress, though he said the administration remains open to it in a different form.

Whew! That's a lot to chew on. We wouldn't agonize over the particulars, though. Like any tax reform, it would create winners and losers. But it's impossible to gauge whether the winners outnumber the losers, because there just isn't enough information. The devil's in the details, and there is a long journey from "List of Roughly Sketched Tax Concepts" to fully fleshed-out amendments to the US tax code. It will evolve, likely a lot, as the administration drafts the whole shebang and Congress goes through it with its metaphorical red pen.

The implications for stocks are also hazy. Since even tax "cuts" benefit some (who get the breaks) at the expense of others (who pay for them), they aren't automatically bullish or bearish. Though many perceive tax cuts as an obvious sentiment boost, prospect theory tells us the inevitable losers' disappointment can outweigh the winners' joy. Much also depends on how expectations form around eventual legislation, and how reality compares to those expectations. Pervasive pessimism sets up positive surprise, and vice versa.

Tough sledding likely awaits on Capitol Hill. While Republicans are thus far presenting a mostly united front, deficit hawks may balk if they don't buy the President's argument that faster economic growth will make up for an initial revenue shortfall. And eliminating deductions for individuals and businesses to reduce strain on the budget is a tall order. Every credit and deduction has a fairly large lobby supporting it,^[i] and a lot of money will go toward preserving them. Lawmakers, whose primary goal is re-election, tend to bow to such pressure.

Further complicating matters, any lasting tax reform would require Democratic support in the Senate. If the GOP uses "budget reconciliation" (permitting a budget bill's passage with a simple majority), they'd have to make the cuts temporary, since reconciliation is off limits for bills that add to the deficit after 10 years. That sets up more uncertainty down the line, when the changes are about to sunset, a la the Bush tax cuts during President Obama's first term. Those temporary 2001 cuts are why we had the infamous fiscal cliff in 2012, among other annual squabbles over extension. Plus, a new party in power can easily undo laws passed along party lines, as they're an easy political target. This uncertain (and potentially short) lifespan makes it harder for businesses to plan long term, reducing temporary reform's impact.

While the administration and Congressional leadership are gunning for success here, it shouldn't surprise if horse-trading and compromise change the plan significantly before it comes up for a vote (presuming it does). Tax changes tend to move slowly, sapping surprise power-a big reason markets usually discount them well before they actually take effect. As a result, they just aren't huge drivers.

Nonetheless, our outlook for markets remains bright. Stocks have risen without landmark tax legislation, and whether tax reform passes in some form or falls short, the global bull market should soldier on.