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Tax Reform: Let the Negotiations Begin
Last week, key tax-policy players in Washington put out a framework of their tax reform goals. While the nine page plan leaves a lot of unanswered questions, it is a starting point for what promises to be a long and difficult negotiation.
Why Reform?
There are two key reasons why tax reform is being debated now. First, the tax code's complexity is a costly burden for both taxpayers as well as the IRS. Remember, the federal tax code went from 400 pages in 1913 to over 74,000 pages
in 2013. Ninety percent of filers pay a fee to have their taxes prepared, and time and money spent on the annual chore was estimated to cost $409 billion in 2016*. The IRS periodically conducts a "tax gap" study, their latest of which found that actual taxes paid lag true tax liabilities by about 16% or an annual loss of $406 billion. Therefore, a simpler tax code, one that is easier for individuals and businesses to comply with, and easier for the IRS to administer, could result in billions of dollars' worth of increased revenue and productivity.
Second, according to the Congressional Budget Office, the US has a corporate tax rate that is "among the highest in the world."
These high rates hurt our economy, and American workers, by driving out investment. Additionally, the tax rate app
lies to profits regardless of where they are earned worldwide, but only when that money is brought back to the US-based parent company. This creates incentives for businesses to keep profits offshore or to reincorporate in a foreign country that doesn't tax their worldwide profits.
The Framework
Listed below are the key tax reform features outlined by Treasury Secretary Steven Mnuchin, and Director of the National Economic Council, Gary Cohn.
- The seven current individual income tax brackets will be consolidated to three: 12, 25, and 35 percent. And, Congress can add a fourth bracket above 35 percent.
- The standard deduction will be raised to $24,000 for couples and $12,000 for individuals, a near doubling from current levels.
- The child tax credit, currently $1,000, will grow to an unspecified higher level. It will also be expanded to more high-income households; it currently phases out at $75,000 in income for single parents and $110,000 for married couples.
- Mortgage interest and charitable deductions would remain but almost all other tax deductions would go, including the deduction for state and local taxes. Retirement incentives like 401(k) and IRA provisions, as well as the exclusion for health care, would remain.
- The corporate income tax rate will be lowered from 35 percent to 20 percent.
- Foreign income by US companies will be tax-free, and all untaxed income currently held oversees will be immediately taxed at a fixed rate. This one-time tax will have different rates for money held in liquid assets (cash or securities) and less liquid assets like factories.
- Instead of having companies "depreciate" investments by deducting them over several years, companies could immediately expense all their investments.
- "Pass-through" companies would pay a lower 25 percent rate rather than the top individual rate which they pay currently.
- The Alternative Minimum Tax is repealed.
- The estate and gift tax is abolished.
What does the market think?
Although the proposal lacks details and negotiations could be difficult, the market appears to believe tax reform is more likely than not. For one thing, Republicans need a win; they are investing a lot of political capital into tax reform and there is general agreement across the party on the need for lower taxes. And, market-based barometers of policy sentiment appear supportive.
Small cap stocks as well as stocks in the financials sector, tend to be more domestic, pay higher taxes, and therefore tend to be bigger beneficiaries of tax reform; they are rallying. More growth and more inflation tend to push interest rates higher, and the Trump administration's US focused trade policy is generally bullish for the US dollar. All these areas have also risen in the past month.
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US Equities ended the week, and month and quarter, higher. The technology sector was especially strong last week, helped by a rebound in Apple shares and strength in semiconductor stocks. Investors appeared to welcome the new Republican tax reform plan that was unveiled Wednesday. Specifically they are encouraged by plans for a lower top tax rate, the elimination of the alternative minimum tax (AMT), and the treatment of foreign corporate profits currently accumulated overseas as already repatriated.
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> GDP:
The final reading of the second quarter GDP rate was revised up to 3.1%. The economy at its core remains stable, as steady job growth and a booming stock market encourage households to spend.
> Volatility:
Though many observers have been warning of increased volatility, it has yet to materialize. Last month was the least volatile September for the S&P 500 on record (according to reliable single-day data going back to 1970).
> Crude Oil:
Crude oil is an important commodity in the global market, and because of that, it can also help determine the direction of inflation. Refineries are upping their production following the hurricane interruptions, operating at 88.6% of capacity, up 5.4 percentage points following a 5.5 point increase in the prior week.
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Like all Americans, our hearts go out to the families and victims of the senseless violence in Las Vegas this week. And our tremendous gratitude goes out to the heroic first responders.
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New Market Wealth Management offers modern investment solutions backed by extensive research and experience serving the needs of wealthy families. Through our strategic partnership with
Cliffwater LLC
, we have access to institutional-quality research, investment due diligence and asset allocation tools. We believe this level of experience and unique access to in-depth, sophisticated research are essential for success in today's complex world markets.
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