“The hardest thing in the world to understand is the income tax.” – Albert Einstein
“The income tax created more criminals than any other single act of government.” – Barry Goldwater
“The purpose of a tax cut is to leave more money where it belongs: in the hands of the working men and women who earned it in the first place.” – Bob Dole
“It’s beginning to look a lot like Christmas.” – Bing Crosby
As we near the end of a historic November, I hope that everyone had a nice Thanksgiving holiday. It’s always my favorite… good food and companionship with no overhang of expectations for the proper gift. Investors had plenty to appreciate, as the major averages rose for the eighth consecutive month. For portfolios, it is indeed beginning to look a lot like Christmas.
We’ve opined at length about the reasons for the stock market’s continued success. Low interest rates, buoyant consumer confidence, solid corporate earnings, an accommodative Federal Reserve, stable balance sheets, no extreme exogenous events… they all add up to an Oz-Like setting for equities. This backdrop is mirrored by the lack of action in the Volatility Index (VIX) which remains at historically low levels. The cake, so to speak, of all the above factors has been in the oven for quite some time. Now, we presumably are going to get the icing of tax reform to sweeten things further.
On Tuesday, the Senate moved its version of a tax bill out of committee into the full elected body. The House has already passed its version. Both have been accomplished along party lines, with Democrats having little or no say in the matter. Given the current state of affairs in Washington, this should come as no surprise. The attempted repeal and replace Obamacare effort evolved in a similar manner, but passage was stymied by a few Republican non-sycophants. Even though I’ve been skeptical about anything getting done on the tax front, I’m not now. The simple fact is that if Congress is unable to put something substantive on the President’s desk for signature before year-end, the Trump administration would have the unenviable record of being unable to pass a single piece of legislation in its first year. Let’s not forget that mid-term elections are less than a year away. Going to voters empty-handed doesn’t seem like a recipe for success. I honestly feel that tax reform is an expediency for Republicans who need desperately to get something done, regardless of whom it benefits.
The House and Senate plans have many common themes, but also some stark differences. As of this writing, let’s note some of the facets:
- Corporate tax rates lowered to 20% from current much higher levels. Without getting too technical, the 20% rate would apply in full to C-corporations. Pass-through rates for LLC’s and S-corps have mathematical offsets that will be helpful to small business, but not at the level of larger multi-national entities.
- The Alternative Minimum Tax would be repealed in both versions.
- Standard deductions would be roughly doubled, so the amount of people who can itemize would be drastically reduced.
- State and local income taxes will in all likelihood not be deductible. This is a “blue” state issue since most states that have high internal taxation (NY, NJ, MA, CA, OR) are Democrat controlled. For those of us in Ohio, we’re faced with the same issue even though the state carried Trump.
- For new home purchases, mortgage interest will be deductible on the first 500K of debt only. This could have a negative effect for housing markets in many expensive real estate areas.
- The exemption for the Federal estate tax would double. This provision affects very few people, but has sizable impact nonetheless.
- The CBO, or Congressional Budget Office, has stated that each version of the bill would add roughly 1.5 trillion dollars to our national debt.
Who are the winners and losers here? (Again, keep in mind that nothing has passed, and that there is plenty of wrangling yet to do.) The obvious winners are large corporations. Not only will tax bills be lessened, but many firms will be able to repatriate tremendous amounts of money held overseas at low rates. Individuals who make over 450K annually will benefit handsomely from the fact that the qualification for top tax bracket incremental treatment will rise to 1MM. The elimination of Alternative Minimum Tax will also be a boon for many individuals. The wealthiest families in America will profit from any increase in estate tax exemption. Wall Street should benefit from the added inflow of repatriation dollars.
As for the losers, there is less agreement. While the President is touting whatever bill gets passed as the “largest tax cut in American history”, that may be hyperbole and/or anathema for most Americans. It’s hard to say how lower and middle-class folks will be affected. Yes, standard deductions will increase, but the inability to deduct medical expenses could be deleterious to many. Educational credits for parents with college student dependents are on the chopping block, as are unreimbursed business expenses for employees. Charities could face pressure because even though contributions per se are deductible, they won’t be for people who cannot itemize. Might the giving mindset be affected? I already alluded to restrictions on deductibility of home mortgage interest on new purchases. Property tax write-offs also look to be axed, so what will be the effect on the housing market?
As a CPA along with being an investment advisor, I’m obviously following all of these gyrations closely. We have to look at tax planning with the facts as we have them today. If a bill gets passed before year-end, there is little likelihood that any provision will be retroactive for 2017. There will be changes beginning in 2018, but it’s impossible to determine their impact until we get further clarity. You can count on us to be proactive with regard to your individual situation. We haven’t had tax reform in over three decades, so we’re long overdue. Last time around, the results were largely productive because there was bi-partisan support between Congress and the Reagan administration. Without any Democratic input, the efficacy of this version may be muted. We’ll just have to wait and see.
We continue to be thankful for your trust and support. Please call or e-mail with your thoughts… have a terrific holiday season.
The opinions expressed in this letter are those of William Schiffman and should not be construed as specific investment advice. All information is believed to be from reliable sources; however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.
Diversification cannot assure a profit or guarantee against a loss.