The House Passed The Tax Bill. What's The Next Step?
Last night the house passed the Tax Cut & Jobs Act Bill with ease. Next up is the Senate vote. It’s important to understand the House and the Senate are voting on two different tax reform bills. Below is a chart illustrating the main differences between the House version and the Senate version of the tax reform bill.
Last night the house passed the Tax Cut & Jobs Act Bill with ease. Next up is the Senate vote. It’s important to understand the House and the Senate are voting on two different tax reform bills. Below is a chart illustrating the main differences between the House version and the Senate version of the tax reform bill.
As you can see, there are a number of dramatic differences between the two bills. The easy part was getting the House to approve their version because the Republican Party own 239 of the 435 seats. In other words, they own 55% of the votes.
The Senate Vote
Next, the Senate will put their tax reform bill to a vote. The vote is expected to take place during the week of Thanksgiving. However, in the Senate , which the Republican have the majority, they only have 52 of the 100 seats. In this case, they would need at least 50 “Yes” votes to get the bill approved in the senate. It’s 50, not 51 votes, because in the event of a “tie”, the Vice President gets a vote to break the tie and he is likely to vote “Yes” to keep tax reform moving along.
Reconciliation Process
Once the House and Senate have approved their own separate tax bills, they will then have to begin the reconciliation process of blending the two bills together. This will be the difficult part. The two tax bills are dramatically different so there will be a fair amount of grappling between the House and the Senate committees as to which features stay and which features get tossed out or adjusted as part of the final tax bill. In the end, the final tax reform bill cannot add more than $1.5 Trillion to the national debt over the next 10 years. Otherwise, the bill would need to return to the Senate and would require “60” votes to approve the bill. There is a slim too no chance of that happening.
Tax Reform by Christmas
President Trump wants the bill on his desk to sign into law before Christmas. While it seems likely that the Senate will pass their tax bill next week, the battle will take place in the reconciliation process that will begin immediately after that vote. It’s a tall order to fill given that there are only six weeks left in the year and how different the two bills are in their current form. However, don’t underestimate how badly the Republican party wants to put a run on the scoreboard before the end of the year. If they get tax reform through in the last week of the year, it’s an understatement to say that it will be an intense final week of December for year-end tax planning. Stay tuned for more………
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Tax Reform: At What Cost?
The Republicans are in a tough situation. There is a tremendous amount of pressure on them to get tax reform done by the end of the year. This type of pressure can have ugly side effects. It’s similar to the Hail Mary play at the end of a football game. Everyone, including the quarterback, has their eyes fixed on the end zone but nobody realizes that no
The Republicans are in a tough situation. There is a tremendous amount of pressure on them to get tax reform done by the end of the year. This type of pressure can have ugly side effects. It’s similar to the Hail Mary play at the end of a football game. Everyone, including the quarterback, has their eyes fixed on the end zone but nobody realizes that no one is covering one of the defensive lineman and he’s just waiting for the ball to be hiked. The game ends without the ball leaving the quarterback’s hands.
The Big Play
Tax reform is the big play. If it works, it could lead to an extension of the current economic rally and more. I’m a supporter of tax reform for the purpose of accelerating job growth both now and in the future. It’s not just about U.S. companies keeping jobs in the U.S. That has been the game for the past two decades. The new game is about attracting foreign companies to set up shop in the U.S. and then hire U.S. workers to run their plants, companies, subsidiaries, etc. Right now we have the highest corporate tax rate in the world which has not only prevented foreign companies from coming here but it has also caused U.S. companies to move jobs outside of the United States. If everyone wants more pie, you have to focus on making the pie bigger, otherwise we are all just going to sit around and fight over who’s piece is bigger.
Easier Said Than Done
How do we make the pie bigger? We have to lower the corporate tax rate which will entice foreign companies to come here to produce the goods and services that they are already selling in the U.S. Which is easy to do if the government has a big piggy bank of money to help offset the tax revenue that will be lost in the short term from these tax cuts. But we don’t.
$1.5 Trillion In Debt Approved
Tax reform made some headway in mid-October when the Senate passed the budget. Within that budget was a provision that would allow the national debt to increase by approximately $1.5 trillion dollars to help offset the short-term revenue loss cause by tax reform. While $1.5 trillion sounds like a lot of money, and don’t get me wrong, it is, let’s put that number in context with some of the proposals that are baked into the proposed tax reform.
Pass-Through Entities
One of the provisions in the proposed tax reform is that income from “pass-through” businesses would be taxed at a flat rate of 25%.
A little background on pass-through business income: sole proprietorships, S corporations, limited liability companies (LLCs), and partnerships are known as pass-through businesses. These entities are called pass-throughs, because the profits of these firms are passed directly through the business to the owners and are taxed on the owners’ individual income tax returns.
How many businesses in the U.S. are pass-through entities? The Tax Foundation states on its website that pass-through entities “make up the vast majority of businesses and more than 60 percent of net business income in America. In addition, pass-through businesses account for more than half of the private sector workforce and 37 percent of total private sector payroll.”
At a conference in D.C., the American Society of Pension Professionals and Actuaries (ASPPA), estimated that the “pass through 25% flat tax rate” will cost the government $6 trillion - $7 trillion in tax revenue. That is a far cry from the $1.5 trillion that was approved in the budget and remember that is just one of the many proposed tax cuts in the tax reform package.
Are Democrats Needed To Pass Tax Reform?
Since $1.5 trillion was approved in the budget by the senate, if the proposed tax reform is able to prove that it will add $1.5 trillion or less to the national debt, the Republicans can get tax reform passed through a “reconciliation package” which does not require any Democrats to step across the aisle. If the tax reform forecasts exceed that $1.5 trillion threshold, then they would need support from a handful of Democrats to get the tax reformed passed which is unlikely.
Revenue Hunting
To stay below that $1.5 trillion threshold, the Republicans are “revenue hunting”. For example, if the proposed tax reform package is expected to cost $5 trillion, they would need to find $3.5 trillion in new sources of tax revenue to get the net cost below the $1.5 trillion debt limit.
State & Local Tax Deductions – Gone?
One for those new revenue sources that is included in the tax reform is taking away the ability to deduct state and local income taxes. This provision has created a divide among Republicans. Since many southern states do not have state income tax, many Republicans representing southern states support this provision. Visa versa, Republicans representing states from the northeast are generally opposed to this provision since many of their states have high state and local incomes taxes. There are other provisions within the proposed tax reform that create the same “it depends on where you live” battle ground within the Republican party.
Obamacare
One of the main reasons why the Trump administration pushed so hard for the Repeal and Replace of Obamacare was “revenue hunting”. They needed the tax savings from the repeal and replace of Obamacare to carrry over to fill the hole that will be created by the proposed tax reform. Since that did not happen, they are now looking high and low for other revenue sources.
Retirement Accounts At Risk?
If the Republicans fail to get tax reform through they run the risk of losing face with their supporters since they have yet to get any of the major reforms through that they campaigned on. Tax reform was supposed to be a layup, not a Hail Mary and this is where the hazard lies. Republicans, out of the desperation to get tax reform through, may start making cuts where they shouldn’t. There are rumors that the Republican Party may consider making cuts to the 401(k) contribution limits and employers sponsored retirement plan. Even though Trump tweeted on October 23, 2017 that he would not touch 401(k)’s as part of tax reform, they are running out of the options for other places that they can find new sources of tax revenue. If it comes down to the 1 yard line and they have the make the decision between making deep cuts to 401(k) plans or passing the tax reform, retirement plans may end up being the sacrificial lamb. There are other consequences that retirement plans may face if the proposed tax reform is passed but it’s too broad to get into in this article. We will write a separate article on that topic.
Tax Reform May Be Delayed
Given all the variables in the mix, passing tax reform before December 31st is starting to look like a tall order to fill. If the Republicans are looking for new sources of revenue, they should probably look for sources that are uniform across state lines otherwise they risk splintering the Republican Party like we saw during the attempt to Repeal and Replace Obamacare. We are encouraging everyone to pay attention to the details buried in the tax reform. While I support tax reform to secure the country’s place in the world both now and in the future, if provisions that make up the tax reform are rushed just to get something done, we run the risk of repeating the short lived glory that tax reform saw during the Reagan Era. They passed sweeping tax cuts, the deficits spiked, and they were forced to raise tax rates a few years later.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Where Are We In The Market Cycle?
Before you can determine where you are going, you first have to know where you are now. Seems like a simple concept. A similar approach is taken when we are developing the investment strategy for our client portfolios. The question more specifically that we are trying to answer is “where are we at in the market cycle?” Is there more upside
Before you can determine where you are going, you first have to know where you are now. Seems like a simple concept. A similar approach is taken when we are developing the investment strategy for our client portfolios. The question more specifically that we are trying to answer is “where are we at in the market cycle?” Is there more upside to the market? Is there a downturn coming? No one knows for sure and there is no single market indicator that has proven to be an accurate predicator of future market trends. Instead, we have to collect data on multiple macroeconomic indicators and attempt to plot where we are in the current market cycle. Here is a snapshot of where we are at now:
The length of the current bull market is starting to worry some investors. Living through the tech bubble and the 2008 recession, those were healthy reminders that markets do not always go up. We are currently in the 87th month of the expansion which is the 4th longest on record. Since 1900, the average economic expansion has lasted 46 months. This leaves many investors questioning, “is the bull market rally about to end?” We are actually less concerned about the “duration” of the expansion. We prefer to look at the “magnitude” of the expansion. This recovery has been different. In most economic recoveries the market grows rapidly following a recession. If you look at the magnitude of this expansion that started in the 4th quarter of 2007 versus previous expansions, it has been lackluster at best. See the chart on the next page. This may lead investors to conclude that there is more to the current economic expansion.
Next up, employment. Over the past 50 years, the unemployment rate has averaged 6.2%. We are currently sitting at an unemployment rate of 5.0%. Based on that number it may be reasonable to conclude that we are close to full employment. Once you get close to full employment you begin to lose that surge in growth that the economy receives from adding 250,000+ jobs per month. It may also imply that we are getting closer to the end of this market cycle.
Now let’s look at the valuation levels in the stock market. In other words, in general are the stocks in the S&P 500 Index cheap to buy, fairly valued, or expensive to buy at this point? We measure this by the forward price to earning ratio (P/E) of the S&P 500 index. The average P/E of the S&P 500 over the last 25 years is 15.9. Back in 2008, the P/E of the S&P 500 was around 9.0. From a valuation standpoint, back in 2008, stocks were very cheap to buy. When stocks are cheap, investors tend to hold them regardless of what’s happening in the global economy with the hopes that they will at least become “fairly valued” at some point in the future. Right now the P/E Ratio of the S&P 500 Index is about 16.8 which is above the 15.9 historic average. This may indicate that stock are starting to become “expensive” from a valuation standpoint and investors may be tempted to sell positions during periods of volatility.
Even though stocks may be perceived as “overvalued” that does not necessarily mean they are not going to become more overvalued from here. In fact, often times after long bull rallies “the plane will overshoot the runway”. However, it does typically mean that big gains are harder to come by since a large amount of the future earnings expectations of the S&P 500 companies are already baked into the stock price. It leaves the door open for more quarterly earning disappointments which could rise to higher levels of volatility in the markets.
The most popular question of the year goes to: “Trump or Hillary? And how will the outcome impact the stock market?” I try not to get too deep in the weeds of politics mainly because history has shown us that there is no clear evidence whether the economy fares better under a Republican president or a Democratic president. However, here is the key point. Markets do not like uncertainty and one of the candidates that is running (I will let you guess which one) represents a tremendous amount of uncertainty regarding the actions that they may take if elected president of the United States. Still, under these circumstances, it is very difficult to develop a sound investment strategy centered around political outcomes that may or may not happen. We really have to “wait and see” in this case.
Let’s travel over the Atlantic. Brexit was a shock to the stock market over the summer but the long term ramifications of the United Kingdom’s exit from the European Union is yet to be known. The exit process will most likely take a number of years as the EU and the UK negotiate terms. In our view, this does not pose an immediate threat to the global economy but it will represent an ongoing element of uncertainty as the EU continues to restart sustainable economic growth in the region.
The chart below is one of the most important illustrations that allows us to gauge the overall level of risk that exists in the global economy. When a country wants to jump start its economy it will often lower the reserve rate (similar to our Fed Funds Rate) in an effort to encourage lending. An increase in borrowing hopefully leads to an increase in consumer spending and economic growth. Unfortunately, countries around the globed have taken this concept to an extreme level and have implemented “negative rates”. If you buy a 10 year government bond in Germany or Japan, you are guaranteed to lose money over that 10 year period. If you have a checking account at a bank in Japan, instead of receiving interest from the bank, the bank may charge you a fee to hold onto your own money. Crazy right? It’s happening. In fact, 33% of the countries around the world have a negative yield on their 10 year government bond. See the chart below. When you look around the globe 71% of the countries have a 10 year government bond yield below 1%. The U.S. 10 Year Treasury sits just above that at 1.7%.
So, what does that mean for the global economy? Basically, countries around the world are starving for economic growth and everyone is trying to jump start their economy at the same time. Possible outcomes? On the positive side, the stage is set for growth. There is “cheap money” and favorable interest rates at levels that we have never seen before in history. Meaning a little growth could go a long ways.
On the negative side, these central banks around the global are pretty much out of ammunition. They have fired every arrow that they have at this point to prevent their economy from contracting. If they cannot get their economy to grow and begin to normalize rates in the near future, when they get hit by the next recession they will have nothing to combat it with. It’s like the fire department showing up to a house fire with no water in the truck. The U.S. is not immune to this situation. Everyone wants the Fed to either not raise rates or raise rates slowly for the fear of the negative impact that it may have on the stock market or the value of the dollar. But would you rather take a little pain now or wait for the next recession to hit and have no way to stop the economy from contracting? It seems like a risky game.
When we look at all of these economic factors as a whole it suggests to us that the U.S. economy is continuing to grow but at a slower pace than a year ago. The data leads us to believe that we may be entering the later stages of the recent bull market rally and that now is a prudent time to revisit the level of exposure to risk assets in our client portfolios. At this point we are more concerned about entering a period of long term stagnation as opposed to a recession. With the rate of economic growth slowing here in the U.S. and the rich valuations already baked into the stock market, we could be entering a period of muted returns from both the stock and bond market. It is important that investors establish a realistic view of where we are in the economic cycle and adjust their return expectations accordingly.
As always, please feel free to contact me if you’d like to discuss your portfolio or our outlook for the economy.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
