Your Complete (Updated) Guide To Tax Reform That Will Never Pass

Tax reform is one of those issues that is the worst of all possible worlds – it’s painfully boring to talk about let alone analyze but talking about it and analyzing it are necessary because sweeping changes to the tax code affect everyone.

For his part, Paul Ryan is confident that he’s going to move this thing through the House in time for the turkey pardon.

“We’re on track for moving this through the House before Thanksgiving. That’s our plan,” Ryan told Fox News on Sunday.

 

That may indeed be “the plan” but you know what they say about the “best laid plans” – something about how they often go awry as soon as a sitting President calls a Senator from his own party ”Liddle Bob’ on Twitter.

As for the Senate, Ryan said that House Republicans “expect our friends in the Senate to be about a week behind us.”

Got that? No? That’s ok, because nobody understands what the fuck is going on here, least of all Paul Ryan. This has become the most convoluted legislative endeavor in recent memory save maybe the bungled attempt to repeal and replace Obamacare and there’s a lot of irony there considering both health care reform and tax reform were high on Trump’s agenda.

As you’re undoubtedly aware, the market has been pricing this out – and “bigly” despite Steve Mnuchin’s contention that taxes are somehow “baked in” to the equity rally.

I mean maybe Steve is right to say that what you see reflected in record highs on the benchmarks reflects tax reform expectations, but somehow I doubt it. Because high tax stocks have been faded relative to the broader market all year, this year has been all about growth in the growth vs. value debate, and the curve is the flattest it’s been since the crisis. So you know, I’m not sure any of that fits neatly in some thesis about reflation euphoria.

Anyway, Goldman is out with something new on this and to let them tell it – and fuck me runnin’, they should know, right? I mean after all, Gary Cohn is supposed to be the guy gettting this done – “there is a 65% chance of enactment by Q1 2018.” First, here’s a “simple” table that shows you how this train wreck has evolved over time:

Taxes

And here are three reasons Goldman says you should be optimistic – if guardedly so:

  1. First, tax reform—and a net tax cut—is an area where the President and most congressional Republicans generally agree. This is notable, since there are substantial differences within the Republican Party on a number of other issues, including immigration, infrastructure, international trade and health reform.
  2. Second, congressional Republicans face a difficult midterm election in 2018 and many lawmakers believe Republican prospects would be improved by a major legislative achievement before voters head to the polls. Republicans tend to be more supportive of most of the general aspects of tax reform than Democratic voters, though some tax changes are more popular than others; middle-class tax cuts and small-business relief enjoys broad support, while corporate tax cuts do not.
  3. Third, tax legislation can pass in the Senate with only 51 votes, instead of the customary 60 votes, through the budget reconciliation process. Now that a majority of the House and Senate have passed a budget resolution calling for a tax cut of up to $1.5 trillion over ten years, the odds would seem low that they would fail to follow through in passing the tax legislation itself

You’ve gotta love the bit about it being “notable” that a Republican President and most Republican lawmakers are all on the same page about something. Equally amusing is the list of things they are not on the same page about: “immigration, infrastructure, international trade and health reform.” So basically, “everything else.”

Additionally, I’ve never been sure that it says much for the state of American politics when the only motivation for getting something done is that midterms are coming up. It’s almost like they’re legislating in order to get reelected rather than getting elected in order to legislate.

For the pessimists out there, here are Goldman’s reasons for how this could – and this a quote – “run off the rails”:

  1. First, tax reform is much harder than tax cuts. The recently introduced House proposal is a case in point. While the proposal achieves meaningful reductions in individual and corporate tax rates, it also targets a number of specific tax benefits and several important constituencies have come out against the bill. This is the main risk to passing tax reform with only Republican votes, in light of the slim Republican majorities in both chambers.
  2. Second, although House and Senate majorities voted in favor of a budget resolution including an instruction to cut taxes by up to $1.5 trillion over ten years, a few of these lawmakers have expressed some hesitation regarding the tax legislation itself. Senator McCain (R-AZ), for example, has called for the legislation to be considered under “regular order” and might not support a tax bill passed via the reconciliation process. Senator Corker (R-TN) supported the budget resolution but has left open the possibility that he would oppose the tax bill itself if he feels it would add to the deficit beyond the estimated revenue gain from economic growth effects and the cost of extending expiring provisions.
  3. Third, while few argue against the concept of revenue neutral reform that lowers statutory tax rates and broadens the tax base, there are good arguments against a large net tax cut at the moment, including a high debt-to-GDP ratio, growing fiscal imbalances projected over the coming decade, and an economy with little remaining slack. This stands in contrast to the 1981 and 2001 tax cuts, when the federal budget was projected to run surpluses, the debt-to-GDP ratio stood at less than half of its current level, and the economy was in recession.

I’m sorry, but the reasons to be pessimistic seem far more concrete than the reasons to be optimistic. And as you can see from the following flow chart, we are a long ass way from the finish line:

Taxes2

And finally, the betting odds:

Taxes3

Needless to say, this by no (ways and) means what Trump had in mind in terms of how quick and seamless this process would be. And yet he continues to pretend as though the problem is lawmakers.

In part, he’s right. No one has ever accused Congress of being particularly efficient – or at least not in recent memory. That said, if you’re Trump it doesn’t help when you’ve also tasked the same Congress with overhauling the entire health care system, reworking the Iran nuclear deal, figuring out what to do with DACA after you’ve already scrapped it, and on and on. Then, to add insult to injury (figuratively and literally), you’re all over Twitter telling them how terrible they are.

So yeah, I’m willing to give Goldman the benefit of the doubt on the 65% number because again, they should by all rights have a better read on this than I do, but in the immortal words of DealBreaker’s Thornton McEnery:

… it seems like we’re forgetting to correct for the data point that Donald Trump is the fucking President of the United States.

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2 thoughts on “Your Complete (Updated) Guide To Tax Reform That Will Never Pass

  1. There are many different ways to categorize households as between those that are middle class and those that are rich. Likewise, there are a number of ways to measure how a change in the tax code impacts various sectors in the economy. There are also different methodologies used to calculated what percentage of federal taxes are paid by middle class households as compared to the rich. However, by an conceivable way of delineating the middle class from the rich, and measuring the impact of changes in the tax code, any tax bill enacted this year or next will be the most massive shift in the tax burden away from the rich and thus onto the middle class.

    We have seen this story before. It is not just a coincidence that tax cuts for the rich have preceded both the 1929 depression and the 2007 financial crisis. The Revenue acts of 1926 and 1928 worked exactly as the Republican Congresses that pushed them through promised. The dramatic reductions in taxes on the upper income brackets and estates of the wealthy did indeed result in increases in savings and investment. However, overinvestment (by 1929 there were over 600 automobile manufacturing companies in America) caused the depression that made the rich, and most everyone else, ultimately much poorer.
    The quandary for investors can be described as someone who has seen the first and last page of a book, but does not know either how long the book is or what happened between the first and last pages. We know that a massive transfer to the rich will happen. We know that the middle class has a much higher marginal propensity to consume than the rich. We know that initially the rich, or if you rather the job creators, use their additional after-tax income to invest. This extra investment initially boosts securities prices. The higher prices for securities enables investments to occur that might have otherwise been undertaken. These can range from factories, shopping centers and housing. What we don’t know is the path that equity prices and interest rates will take between the enactment of the tax shift and the eventual financial crisis or any other event occurs. At that point in time, the massive excess of supply of loanable funds as compared to demand for loans will push risk-free short-term interest rates down to near the lower bound, as was the case during the 1930s in Japan for decades and in America since 2008.

    The length, path and magnitude of a tax-shift induced cycle is particularly important to investors in leveraged instruments, such as high yield 2X leveraged ETNs. No two overinvestment cycles are identical. This time the picture is cloudier since most of the shift from in the tax burden from the wealthy to the middle class will be via reductions in business taxes. Reducing taxes on corporations would not increase economic activity. A profit-maximizing corporation will make decisions relating to the level of production, wages and prices that maximize after-tax profit. Since corporate income taxes are a percentage of pre-tax profits, the level of output, wages and prices that maximize pre-tax profits are also the same levels that maximize after-tax profits. This was explained in: Get 16.8% Dividend Yield, And Diversify Some ETN Interest Risk. However, that does not mean that changing corporate taxes, other than the rate, cannot impact economic activity.
    Allowing immediate expensing of capital expenditures or even just allowing vastly increased accelerated depreciation could bring forward capital expenditures that would have otherwise have taken place in the future. This would be particularly powerful if the immediate expensing or extra accelerated depreciation was set to only last for a specified period. Allowing immediate expensing of capital expenditures could even cause projects that would otherwise be not accepted on a net-present value analysis, be undertaken as a result of now having expected internal rates of return exceeding the hurdle rate.

    There is also a “geographical Laffer Curve effect” when different taxing jurisdictions cause activity to shift from higher tax jurisdictions to those with lower taxes. Generally, this is more pronounced the closer the different jurisdictions are. People driving from New York to New Jersey to pay less sales taxes when they shop are an example. Lower corporate taxes in the U.S. could shift some activity from other countries. Allowing repatriation of corporate profits now nominally held in other countries or just eliminating taxes on foreign earnings could boost the value of shares in multinational corporations. These would include Apple (AAPL) and possibly even General Motors (GM). Most major profitable multinationals have ample access to capital regardless of where their cash is located. Thus, very few multinational corporations are not undertaking any projects because of where their cash is located.
    In terms of reallocating the shares of the tax burden between the middle class and wealthy, the share paid by the rich would decline, although not as sharply, even in the unlikely event that Trump circumvents the Republican leaders and makes a deal with the Democrats. This might occur if the Republicans are unable to enact tax legislation, as was the case with repeal of Obamacare. In passing the debt ceiling and government funding legislation, Trump did work with the Democrat leaders, much to the consternation of the Republican leaders. As was described in How A Trump-Schumer Tax Deal Could Impact Financial Markets:n https://seekingalpha.com/article/4113472

    Totally eliminating the estate tax and the deductions of state and local taxes would probably be a non-starter for Democratic leaders Chuck Schumer and Nancy Pelosi. However, many Democrats and some Republicans would be willing to go with a compromise that might increase the threshold below which no estate taxes are paid to $25 million. Likewise, Democrats and some Republicans might support keeping the deductions for state and local taxes, but limiting the amount that any individual filer could deduct to say $100,000. Compromise on estate tax and the deductions of state and local taxes could be viewed favorably by Trump. This would remove those topics that are now albatrosses around Trump’s neck, since they are the clearest evidence that directly refutes Trump’s promises that all middle-class taxpayers would benefit from the tax reform plan and that the very wealthy such as himself would not.

    The area where common ground could be found between Trump and the Democrats is corporate taxation. The falsehood that corporations do not pay income taxes, but rather their customers and employees do, has been repeated many times by those who do not understand economics and by some who epitomize Upton Sinclair’s famous statement that “it is difficult to get a man to understand something, when his salary depends upon his not understanding it.”

    Many, possibly including Chuck Schumer and Nancy Pelosi, do not know that the incidence of a corporate income tax falls entirely on the shareholders of the corporation. Even more, probably do not understand why that is case, nor could they explain it.

    Even if was widely understood that the incidence of a corporate income tax falls entirely on the shareholders, not all shareholders are in the top 1% or even wealthy. That could make it easier for Democrats to accept lower corporate taxes as compared repeal of the estate tax, which only benefits the extremely wealthy. To the extent that poor and middle class people are owners of shares the corporations, the incidence falls on them too. However, the reduction in corporate income tax receipts as a percentage of GDP has been the primary cause of the shift of the tax burden to the middle class from the rich. Corporate income tax receipts were 4% of GDP in 1969 and were 1.77% in 2016. During that same period, payroll tax rates as a percent of GDP have increased dramatically from 3.27% in 1966 to 5.95% in 2016…”
    https://seekingalpha.com/article/4120502

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