Wall Street was underwhelmed on Wednesday by the release of President Trump's plan for the biggest tax cuts ever and a stock-market fantasy 15% corporate tax rate.
JPMorgan Chase analysts called the plan "virtually impossible to pass," and some analysts said it might be a step backward for tax cuts because of the White House's insistence that an economic acceleration to 3% GDP growth would largely cover the cost.
That reaction may explain why the Dow Jones industrial average, S&P 500 index and Nasdaq composite all turned slight gains into modest losses after the Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn, both Goldman Sachs alums, released a rudimentary outline of their tax plan.
But Goldman Sachs political economist Alec Phillips sees "a good chance that tax legislation becomes law" by the end of the year. "In fact, market sentiment regarding fiscal policy might have become too negative," Phillips writes.
Goldman's analysis, in other words, assumes that the Dow and S&P have climbed back near record territory and the Nasdaq has surged to a new high because of good earnings and a market-friendly French election result, rather than hopes for Trump's fiscal policies.
The Dow industrials, S&P 500 and Nasdaq composite rose fractionally Thursday morning, in part on generally positive earnings.
McDonald's (MCD) and Caterpillar (CAT) have led the Dow's renewed advance toward 21,000 this week on the strength of an improving earnings and sales outlook. Goldman Sachs (GS) and JPMorgan Chase (JPM) have helped pad the gains as the 10-year Treasury yield and Federal Reserve rate-hiking expectations continued to firm up after a stretch of weakness. Meanwhile, Wal-Mart (WMT) rose to a buy zone, hitting a nearly two-year high, as the White House backed away from the tax on imports proposed by House Speaker Paul Ryan as a way to pay for a corporate tax cut.
Clearly, markets aren't just reacting to Trump. It's unclear, though, whether the jump in businesses confidence sparked by Trump's promises will be sustained if doubts grow about the White House's ability to deliver.
The Trump plan calls for cuts in individual tax rates, with the top rate lowered to 35% from 39.6% and a doubling of the standard deduction to $24,000 for couples, to be offset by getting rid of all deductions except those for mortgage interest and charitable giving. That means no more state and local tax deduction, a big deal for high-tax "blue" states such as California and New York.
IBD'S TAKE: The stock market has bounced back near all-time highs, but Treasury yields are still range-bound. Investors seem to have forgotten that the Federal Reserve has begun worrying about asset values and planning to scale back its balance sheet.
In addition to the 35% personal income tax bracket, there would be 25% and 10% brackets, vs. a seven-bracket system now. The plan also would eliminate the estate tax and the alternative minimum tax.
The long-term capital gains tax rate would back to 20%, eliminating the 3.8% ObamaCare/Medicare surcharge.
Mnuchin said the plan would adopt a territorial tax system, with companies paying the local tax rate where the profits are earned. The result would be companies repatriating trillions over dollars to boost U.S. economic growth.
Prospects for deficit-increasing tax cuts will ultimately depend on the Senate Republicans who will have to decide whether they are willing to throw caution to the wind when it comes to the nation's outlook for large and growing deficits and debt.
JPMorgan analysts agree that investors have already reined in their expectations. "At this point investors would be happy to see the corporate rate brought down to ~27%" by the first quarter of 2018. "Expectations for changes to the individual tax code are near zero."
Goldman's Phillips suggests that the corporate tax rate might be cut to 25% from 35%.
Mnuchin may be right that faster economic growth can help pay for the tax cuts — but only to a point.
Even the conservative Tax Foundation judged that the Trump campaign's plan to cut individual and corporate tax rates would raise deficits by at least $2.6 trillion over a decade. However, the nonpartisan Congressional Budget Office and Joint Committee on Taxation might provide a somewhat tougher evaluation.
The Urban-Brookings Tax Policy Center says that Trump's plan for a 15% corporate tax rate and a 15% rate on pass-through businesses (such as sole proprietorships and partnerships whose income passes through to the owners) would cut federal revenue by about $3.3 trillion over 10 years. The left-leaning analysts don't think a deficit-funded tax hike will do much of anything to recoup that revenue via faster economic growth.
Meanwhile, the CBO already has provided an analysis of what an additional $2 trillion in debt over 10 years would mean for the budget outlook. As it stands, CBO sees publicly held federal debt rising from 77% of GDP to an unprecedented 150% by 2047. Assuming Trump's deficit-increasing fiscal policies stay in place, debt would hit 202% of GDP in 30 years.
Here's the harsh conclusion offered last week by Wells Fargo Chief Economist John Silvia and colleagues Michael Brown and Michael Pugliese: "In our view, the long-run costs of nondeficit neutral tax cuts at the projected levels of federal debt would outweigh the short-run benefits provided by the tax cuts. This is particularly true in the current economic environment, where the economy is close to full employment and near potential GDP growth, which historically has the net effect of increasing inflation pressures more than real GDP growth."
The Wells Fargo economists add: "Finding a path to deficit neutral cuts would require reforms to entitlement programs, which many policymakers have a desire to avoid."
Border Adjustment Tax Dropped
There's not much question why Trump has chosen this path that avoids such hard choices. After all, House Speaker Paul Ryan's ObamaCare replacement to slash Medicaid and cut the ranks of the insured by 24 million crashed and burned in the House. Ryan's plan for a 20% tax on imports to pay for corporate tax reform appears just as unpopular. Mnuchin said Wednesday that a border adjustment tax would be "impossible" to pass.
Trump wants a policy that is huge and that has corporate America lined up behind it — rather than taking potshots at it, as Wal-Mart and other opponents of the border tax have been doing.
But it remains to be seen whether there's any such thing as an easy-to-sell policy in the current fiscal climate. Sen. John McCain was the lone Republican to vote against President George W. Bush's tax cuts in 2001, but that was at a time the federal government was running a surplus. It would only take two additional GOP senators to block an unfunded Trump tax plan now. How this all plays out is far from the clear.
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