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Tax Reforms Released as Earnings Season Continues

This week, President Trump released his vision of how corporate and personal taxes should be changed.  Following up on his campaign promise to give a “massive tax cut” to the American public, details include a 15% corporate tax rate, simplified tax brackets for individuals and protection of the mortgage interest deduction and doubling the standard deduction while removing the ability to deduct state and local taxes.  Obviously that would be a big boost to corporate earnings as more cash would flow to the bottom line and be available to be distributed to shareholders.  Small cap stocks that make most of their profits on domestic sales would benefit from lower taxes.  Large multinationals would also benefit if cash is able to be repatriated to the U.S. at a lower rate than currently.  Banks are one sector that would benefit from not only the lowered rate but also a likely boost in customer demand for loans.  Details on how to pay for all this are sketchy.  Dropping the corporate tax rate from 35% to 15% would cost about $2.5 trillion according to various studies.  The total price tag could be as high as $5.5 trillion, depending upon what ultimately survives Congressional debate.

The Trump administration claims economic growth alone could pay for the entire overhaul.  If the lowered tax levels spur companies and the general public to open their wallets and push GDP to 3%+ annual growth on a consistent basis, then maybe this explanation would work.  According to the Commerce Department, the first quarter gross domestic product grew at the slowest pace in three years, eking out 0.7% on a seasonally adjusted annual rate.  In the fourth quarter, GDP grew at a 2.1% rate and economists surveyed by The Wall Street Journal had expected 1% growth.  The biggest issue was sluggish consumer spending, which comprises about two-thirds of output.  Household growth grew by the smallest amount since 2009.  This is highlighting the growing conflict between “soft” data that measures consumer confidence and manufacturing surveys on current conditions and “hard” data which is showing that the economy is actually decelerating when figures are tallied.  Meanwhile, inflation has become more widespread with the S&P CoreLogic Case-Shiller data showing home prices in 20 U.S. cities accelerated for a fifth consecutive month, and the Fed is clearly on an interest rate hike path with the futures market pricing in a 70% chance of officials raising their benchmark rate when they meet in June.   

Granted, there are always seasonal factors at play.  An unusually warm winter has led to lower utility use and played havoc with retailer inventory—why buy a sweater in January when temperatures are in the low 60’s?  Quirks in the calendar means the government did not get the bulk of its income tax revenue until after April 18, three days behind the usual 15th.  In an $18 trillion economy, three days results in a lot of interest not collected!  This quarter’s GDP data also saw a 1.7% fall in government spending that was likely affected by a three-month hiring freeze imposed by the administration.  Most economists expect the economy to bounce back by the second and third quarter and finish the year at 2.2% growth with only a 15% current chance of a recession according to Bloomberg.  So the sky is not falling.  The Commerce Department reported sales of new home sales, a key industry and timely indicator, rose to the highest level since September 2008 even in the face of higher prices.  Nevertheless, to generate potentially a $5.5 trillion gap in the nation’s finances without a concrete plan to cover that debt could be very troubling to the financial markets.  The market’s reaction when the plan was revealed on Wednesday was not much mostly because it was devoid of many details.  Judging from the failure to repeal and replace the Affordable Care Act, investors are waiting until final votes are counted before casting their opinion through trading activity.       


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