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Where do we stand now with tax reform?

Where do we stand now with tax reform?

Guest Post - Monday, October 02, 2017

Described by the administration as 'giant, beautiful and massive,' there is now a draft plan on the table. This has been eagerly anticipated—especially since high hopes for any time of plan had begun to erode in the midst of the fractured Obamacare repeal effort. Although raw, it offers a starting road map for tax cuts and, potentially, although more complicated, more comprehensive tax reform. There weren't a lot of surprises in the first draft, but there is already pushback and this only serves to kickstart the process of further cross-party negotiations in coming months. It's often said about negotiations that no one really gets what they want, but hopefully in the end everyone can live with the outcome (although this seems to have become more difficult in Washington in recent years). The more radical reforms discussed in pre-election campaign talk have been scaled back, although there are several items that remain controversial. As you might expect, every component on a tax return has a unique constituency and lobbying effort.

There are several potential individual tax line items still in play, including repeal of the alternative minimum and estate taxes, simplifying the number of brackets down to three, doubling the standard deduction (to account for the removal of many itemized deductions, including those for state/local taxes paid and others). Hot button items tend to be in the itemized deductions category, especially those for mortgage interest and charitable donations (which appear to be off the table for now) since these affect the largest number of middle-income taxpayers.

The corporate side has also been scaled back. The border-adjusted tax idea has faded, due to its complexity and fact that it offered uncertain and possibly inequitable repercussions on import vs. export activity, not to mention unpredictable currency effects and potential tariff retaliation by other nations. However, there may be tweaks in a move toward a more 'territorial' system—where companies are taxed only in jurisdictions in which profits are created. A goal has been to reduce the incentive for companies to keep cash/assets offshore, while also lowering overall corporate tax rates to more globally-competitive levels.

From an investment standpoint, this is meaningful, as lower tax rates equate directly to higher net profits—which is the 'hope' markets appear to have been pricing in for months. Higher profits justify higher equity valuations. Naturally, there are other assumptions included in that, such as higher GDP growth, which could increase inflation and the Fed's pace of increasing interest rates (which could theoretically also rise due to higher U.S. debt levels that has the potential of pressuring borrowing costs upward). All of these remain hypotheticals at this point.

Long story short, there is a stronger likelihood that this will amount to at least some change, which is what markets appear to have been hoping for—especially on side of corporate taxes. It still may be scaled back further in order to avoid widening the federal deficit any more than it's already expected to (estimates are broad and range from $1-3 trillion over the next decade, based on various 'scoring' systems, and could be lower based on the amount of growth generated by the changes). At this point, it's not quite the full tax reform many have been clamoring for, but probabilities for action have risen; now, it's about specifics.

Read our Weekly Review for October 2, 2017.

Read the previous Question of the Week for August 28, 2017.

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