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Looking Under the Hood of the 2017 Tax Reform Bill

2017 Tax Reform Bill
2017 Tax Reform Bill

Below we look at the 2017 tax reform bill passed this week. As we quickly discover, it’s pretty thin on substance but big on public optics. Furthermore, we know that tax talk is boring, but given how symbolic this anticipated tax reform bill has been for market enthusiasm, it’s worth a few paragraphs here to also see what this tax reform bill means for the markets.

Form over Substance

The Senate Finance Committee passed a tax reform bill. Now What? What’s in it, how does it work, and does it really matter?

Well, first let’s just sift through the media noise and political opportunism and see what it boils down to.

Who benefits? That’s easy. Us on Wall Street, big corporations and the lobbyists on K-Street. Who loses? Drumroll the obvious…Main Street America, again.

In terms of substance, this tax bill is wafer thin. It essentially allows for $1.4T in tax relief between 2018-2025 with no “pay-fors”—meaning the tax revenue losses (approximately 4% of current tax revenue collections over the next 8 years) it offers are to be deficit-financed, i.e. deficit fatteners, with no simultaneous spending cuts.

No surprise there.

As for the lauded revenue hit, please know that by comparison, the Reagan tax cuts in 86 reduced tax revenues by 26%, not the current bill’s 4%. In short, hardly a huge event anyway, but politically needed…

How it Works?

The bill reduces the marginal tax rate in the top tax bracket from 39.6% to 38.5%. Yawn. The big item here is the 20% corporate tax rate cut, which enjoys a permanent tax break status, whereas by year 2027, individual filers—i.e. normal Americans—get no tax cut. The bill also gives small business owners a minimal pass-thru tax reduction, which also expires (or “sunsets’’) by year 10.

Also included in the tax bill is the repeal of the individual mandate under Obamacare, which many of our readers will applaud, and others not.

Without getting too political here, the presumption in this tax bill is that low income families will willingly abandon Obamacare’s tax subsidies (worth about $15,000 to $20,000) in order to avoid the $2000 fines some are forced to pay for foregoing the program. Hmmmm.

After 2025, the tax bill then aims to increase rather than cut tax revenue by 2027 to the relatively small tune of $30B, but without requiring corporations to pay more.

Can-Kicking at Its Finest

Ironically then, and as one looks a bit deeper under the hood of this low-cylinder tax bill, the tax cut is in fact nothing more than a postponed tax hike. It is predominantly pro-corporation, not pro tax payer. More importantly. It’s just more of the same deficit financing (and deficit fattening), and hence debt can kicking, all hiding behind a headline-making “tax cut” for political optics.

What does it cost? The tax bill will result in a loss of revenues of at least $2T over the next 10 years. They’ve also tucked in a clever little face-saver called the “Byrd Rule” which would strike down any reconciliation bills that would otherwise increase our already bloated deficit after 10 years from now.

Most of us, by now, can see right through this, though I’m glad it is at least there. The Byrd Rule is a clever, face-saving way of looking “responsible” while simultaneously kicking the debt can a decade in to the future in order to “solve” our current deficit problem by, well, simply ignoring it.

Once again, DC was not able to consider the more realistic option of the otherwise politically unthinkable—namely spending cuts, rather than deficit hikes.

Look, I’m all for tax cuts—but we need to marry those tax cuts with equal spending cuts. Just like a family in debt, we can’t keep buying more toys on credit cards until we cut back spending in equal amounts elsewhere.

If prudent folks can understand this on Main Street, why can’t prudent politicians (red or blue) accept this on the Hill? Likely, the answer is because they want to be electable rather than reasonable.

Bottom line: the tax bill offers a temporary (and minimal) tax break for individuals and small businesses that expires in 10 years, yet grants big corporations (i.e. those we’re trading on the stock market) a permanent and significant tax break, with the logic that the $1.3T in corporate tax relief “savings” will trickle down to Main Street economic growth over the next 10  years.

As any of you who have been “trickled on” know by now, it hardly feels “stimulative.” The simple fact is there has been no evidence that corporate tax cuts lead to economic growth. Not in the Reagan era and not today.

But there’s plenty of evidence that such tax cuts have and do result in more revenue for CIO’s, more stock-buy-backs by said corporations and more dividend pay-outs to us shareholders. In short, it’s good for stock market valuation.

The Market Risks Ignored

But at these nose bleed valuations, is it prudent to fatten an already obese securities market with yet another advantage–this time via tax legislation?

More importantly, how will greater deficit-financed tax “cuts” impact our pesky little bond problem, aka bond bubble?

As we as a country keep fattening our deficit bubble, there will be an inevitable rise in interest rates, which harm rather than stimulate real growth.

After all, and as written elsewhere, America survives on debt, not growth. Since the turn of this relatively young century, our deficit has sky-rocketed from $5T to 21T.  Add in public and private debt and this number soars to $66T in debt. This is a staggering number.

And remember: the key drug of our debt addiction is the US Treasury Bill, and for the first time in years, the US Fed will be selling rather than buying our national “IOU’s.” (See my QT article.) As the Treasury sellingkicks in to pay for our ever-increasing national debts, the bond/Treasury prices will dive down, and alas rates will spike up.

It’s that simple.

Political Face-Saving?

For politicians who actually care about the deficit looming over our country like a debt guillotine (i.e. Corker, Lankford, Flake and others), they need to get real and ask themselves if corporate tax cuts will indeed “pay for themselves” via trickle down growth into the real economy as opposed to just flowing (rather than “trickling”) into the executive corner offices and grossly over-valued stock market.

In response, the “Corker-ites” demanded another face-saving but effectively useless clause—namely a “tax increase trigger” to take immediate effect in the event the aforementioned trickle-down growth effect doesn’t take place.

I applaud the hawkish approach to deficits, but one wondered how this “trigger” idea would fly under a full Senate vote? Well, we got the answer. It flew—but with clipped wings. That’s how this wafer-thin, “trigger-vulnerable,” all-optics-no-substance- tax cut got its 51 votes.

No Surprise

As I wrote elsewhere and mentioned in videos early in November, there was never any question that “some kind of bill” had to be passed for Washington to save face and avoid a market reaction. (Though it is sad to see stock markets rather than true economists drive “public policy” and tax matters…).

Even if the tax bill was a dinner bill, they’d have to get 51 votes one way or another. The markets, alas, demanded it.

The Market Wave Continues to Rage Ahead

Not surprisingly, nothing –even a joke of a tax bill–could keep this algo-driven market down. Good grief, not even criminal charges against a former US National Security Advisor (Michael Flynn) and the prospects of him testifying within a Presidential impeachment proceeding could slow these crazy markets.

The sell-side cheerleaders interviewed on Bloomberg continued their rah-rahing even as tax and Flynn stories were filling the radio waves. Some spin doctors, anticipating potential damage control, were even saying a Pence Whitehouse would be good for these markets.

That’s the markets we live in? One in which even an impeachment risk is recycled into a bullish sign? Everything, it seems, from Brexit to terrorism, somehow turns into a bullish indicator…

In sum, the pom poms and puff pieces essential to mollifying market fears just poured over the nation to quell market concerns rather than address substantive risks about national or economic reality.

But always remember, markets and economies are not the same thing. Wall Street and Washington have been favoring markets over the Main Street for far too long, and the price we’ll pay for this is undeniable, just as the debt burden we’re handing the next generation of Americans is intolerable.

And have we no shame in the MSFM? Regardless of one’s politics, be they Bernie on one side, the Donald on the other, or some place in between, can’t we all agree that markets should be concerned about national and political reality? Just a tiny bit? Nothing, it seems, fazes this mega bubble…

Until, of course, it pops. And it will.

Signals Matter—Candor Matters

Bull or bear, left, right or center, none of us can bury our heads in the sand and ignore our deficit realities, the bond bubble or the equity market over-valuations we are facing. None of us can ignore the unavoidable ramifications of a Fed shifting from a bond buyer (QE) to a bond seller (QT). In short, reality, like the FANG+ Index, is going to bite us hard.

That’s why investors and traders at, regardless of their politics or impatience with the MSFM, are looking at the data, not the hype; the security and trend signals, not the headlines and puff pieces.

Rising markets or falling markets, real news or “fake news,” we’re watching the tape, the Fed, the flows and the signals so that you can manage your investments with candor not candy-coating.

Be smart out there—careful too.

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