HIGHLIGHTS OF THE WEEK
- A very quiet week for economic data had markets anticipating Chair Yellen’s remarks at Jackson Hole. Her speech largely went over old ground on financial stability and the role of regulation.
- Next week, President Trump is expected to join the chorus of Republicans promoting tax reform. We still don’t know the details, but September is likely to see the debate heat up as Congress gets down to brass tacks writing legislation.
- Add to that the potential for an 11th hour solution on the debt ceiling and funding government beyond September, and investors could be kept on the edge of their seats over the next couple of months.
Washington Likely to Keep Markets on Edge
September is likely to keep markets on the edge of their seats awaiting details of tax reform plans, and the potential for fireworks surrounding the debt ceiling and funding government beyond September (see recent report). The GOP surely needs some kind of legislative achievement to show voters in the mid-term elections, raising the stakes to get some kind of tax reform done in short order. Last week’s market turmoil demonstrated just how sensitive markets are to signs that Trump might not be able to implement his lower-tax pro-business agenda.
President Trump is scheduled to start making speeches in support of tax reform next week. Joining in with the chorus of GOP Members of Congress stumping their tax reform plans throughout August. But, we still do not know the details of what that agenda will look like. The high level statement of principles released before the August recess by the “Group of Six”, was meant to give direction to the two tax-reform writing committees (House Ways & Means and Senate Budget) that will hash out the gory details of the package in September.
We know the controversial border adjustment tax is off the table. Reading between the lines of the statement, they are (not surprisingly) seeking to lower the corporate tax rate, lower taxes for “pass-through” businesses, and likely move towards full expensing of capital expenditures. Recent leaks from the process suggest a corporate rate between 22-25% is being considered. The Tax Foundation has estimated that reducing the CIT rate to 25% and allowing full expensing costs $1.2 trillion (tn) over ten years. On the flip side, eliminating the deductibility of interest payment would generate $1.2 tn, at current tax rates. Allowing companies to repatriate cash from overseas at a one-time low tax rate, is almost certain to be included and would generate between $140-150 billion.
On the personal side, there is talk of capping the mortgage interest deduction. That could generate over $300 bn if it is the level of eligible debt is capped at $500K, and would largely be paid by taxpayers in the top 20% of incomes. Repealing the state and local tax deduction, would also generate significant revenue (potentially $1.7 tn). These “pay-fors” could fund lower personal tax rates or double the standard deduction, which would improve simplicity, and benefit middle-income taxpayers the most (see our recent report).
On a back of the envelope basis, these potential tax changes don’t yet appear to be deficit neutral. There are three ways the GOP can overcome this: cut government spending, reduce the size of tax breaks or allow tax cuts to “sunset” like the Bush tax cuts. A sunset clause would create a new fiscal cliff ten years down the line and reduce the economic impact of he changes. Budget proposals have between $4 tn (Trump) and nearly $7 tn (House) in spending cuts relative to CBO’s baseline. While these are unlikely to pass in their current form, they would generate plenty of fiscal room for tax cuts. Or, the GOP could opt for a much more modest package, and call it a “down payment” on further reforms they could implement if they manage to secure a filibuster-proof majority in the Senate in 2018. With markets clearly sensitive to developments in Washington, this fall should prove to be exciting, for better or worse.
Leslie Preston, Senior Economist | 416-983-7053
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