Financial Review

Tax Act

….Dow hits a record high close. Tax Act unveiled – all the details. Powell nominated as Fed head.

Financial Review by Sinclair Noe for 11-02-2017

 

DOW + 81 = 23,516
SPX + 0.49 = 2579
NAS – 1 = 6714
RUT + 3 = 1496
10 Y – .03 = 2.35%
OIL + .44 = 54.74
GOLD + 1.20 = 1276.50

 

Record high close for the Dow Industrial Average. It was just a couple of weeks ago that the Dow crossed over 23,000 and today we top 23,500. Gains in Boeing, 3M, and Goldman Sachs helped push the Dow higher, while losses for Facebook and Tesla weighed on the S&P and Nasdaq.

 

Two big events today: the new tax cut plan was revealed, and Jerome Powell was nominated to be the next Federal Reserve Chairman.

 

Taxes first.

This is the first time Republicans have described their tax plan, the Tax Cuts and Jobs Act, in enough detail that it can actually be debated, scored by the Congressional Budget Office so its cost and effects on the rich and poor are known, and voted upon by the House and Senate. The Tax Act is over 400 pages long.  (here is the full text for your reading pleasure.)

The legislation seeks to dramatically cut taxes on corporations and consolidate benefits like personal exemptions, the standard deduction, and the child credit for individuals. It would eliminate the alternative minimum tax and estate tax, and pare back certain individual deductions. It would also offer a new low tax rate for owners of “pass-through” businesses like LLCs and partnerships, whose income from their businesses is taxed as personal income.

The bill in its current form would almost certainly give disproportionate benefits to wealthy Americans, who tend to benefit from corporate tax cuts more than non-wealthy Americans and who could likely exploit the pass-through rate by setting up dummy corporations. People earning between $400,000 and $1 million would face a significantly lower top income tax rate.

But the bill will almost certainly not remain in its current form. As written, it is almost guaranteed to increase the budget deficit by trillions over 10 years, and quite possibly keep increasing the deficit after 10 years are up.

That’s a big problem: Under Senate rules, some legislation can pass with only 51 votes only if it doesn’t increase the long-run deficit. So the current draft of the legislation would probably need 60 votes instead, meaning significant Democratic support, which Republican leaders haven’t been even trying to court. They need legislation that can pass with 51 votes, and for that, they need the bill to not raise the long-run deficit.

That means the bill needs to change — either the cuts need to get smaller or Republican leaders need to find new ways to raise money, or both. But the bill in its current form at least suggests what GOP leaders want to do.

The new tax reform bill would significantly change individual income tax brackets:

The seven current individual income tax brackets would be consolidated to four: 12 percent (up from the current bottom rate of 10 percent), 25 percent, 35 percent, and 39.6 percent.

12%: Applies to incomes up to $45,000 for an individual and $90,000 for a married couple.

25%: Applies to incomes up to $200,000 for and individual and $260,000 for couples.

35%: Applies to incomes up to $500,000 for an individual and $1 million for couples.

Keeping the 39.6 percent top rate is a huge change from past Republican plans, which have focused heavily on cutting the maximum rate the richest households pay. However, the plan significantly reduces how many people pay the top rate: The threshold for the last bracket would increase from $470,700 for married couples today to $1 million.

The 35 percent rate would cover some affluent households currently paying a marginal rate of 33 percent, potentially raising their taxes; and the 12 percent bracket would extend into the income range currently covered by the 25 percent bracket, lowering taxes for many middle- and upper-middle-class households.

The thresholds for brackets will be adjusted according to chained CPI, a slower-growing measure of inflation than normal CPI, which is used currently; this change raises revenue over time by gradually pushing more and more people into higher tax brackets.

Performance pay and commissions above $1 million would no longer be deductible for the purposes of corporate taxes.

The standard deduction is increased, personal exemptions are eliminated, and the child tax credit is mildly boosted

The standard deduction will be raised to $24,000 for couples and $12,000 for individuals, a near doubling from current levels.

The child tax credit, currently $1,000, will grow to $1,600, and a new $300 credit for parents and other non-child dependents in the house (the $300 credit expires after five years). The child credit would start to phase out at $230,000 in earnings for married couples, as opposed to $110,000 under current law.

The personal exemption (currently offering households $4,050 per person in deductions) is eliminated, replaced in theory by the higher child credit and standard deduction.

The mortgage interest deduction is unchanged for current homeowners, but for all future mortgages, the benefit would be capped at a home value of $500,000, down from $1 million under current law. The real estate industry will scream bloody murder.

The deduction for state and local income and sales taxes would be eliminated. Several states will scream bloody murder.

The deduction for state and local property taxes would be capped at $10,000, somewhat curtailing the current tax break.

The medical expense deduction would be repealed. Seniors will scream bloody murder. Also, interest deductions on student loan debt would be repealed. Deductions for moving/relocation expenses would be eliminated. Also alimony payment deductions eliminated.

Most major tax breaks for individuals — the charitable deduction, retirement incentives like 401(k) and IRA provisions, the tax exclusion for employer-provided health care, the earned income tax credit, and the child and dependent care tax credit — would remain unchanged.

 

The corporate income tax rate will be lowered from 35 percent to 20 percent. The corporate tax will be “territorial”: Foreign income by US companies will be tax-free. All untaxed income currently held overseas will immediately be taxed at a fixed rate: 12 percent for money held in liquid assets like stocks and bonds, 5 percent for intangibles like buildings and factories.

Despite the tax being “territorial” in principle, there will be a 10 percent “minimum tax” imposed on profits above a certain threshold from foreign subsidiaries of US companies in the future, to prevent companies from moving income abroad to avoid taxes. Additionally, any money that multinational corporations move from the US abroad will be subject to a new 20 percent tax.

Instead of having companies “depreciate” investments by deducting them over several years, companies could immediately expense all their investments. This benefit expires after five years, presumably to save money, which dampens any positive effect it has on economic growth.

Companies paying the corporate income tax would face a limit on how much debt they can deduct from their taxable income, a significant change for highly leveraged companies like banks. They could only deduct interest worth up to 30 percent of earnings before interest/taxes/depreciation/amortization. But real estate firms would be exempt from that limit.

Two big existing credits for corporations — the research and development tax credit and the low-income housing credit — won’t be repealed. But a deduction for domestic manufacturing is gone.

“Pass-through” companies like LLCs, partnerships, sole proprietorships, and S corporations, would get a huge number of tax cuts too: Taxes on pass-through income would be capped at the 25 percent bracket rather than the top individual rate. Pass-through companies would still be able to deduct interest on loans in full, unlike C-corporations. The 25 percent bracket creates a huge loophole for rich people, who could incorporate as sole proprietorships and “contract” with their employers so their income is pass-through income rather than wages.

To partially control that, the law would assume that 100 percent of earnings from professional services firms, like law firms and accounting firms, is wages, not pass-through income. For other businesses, people actively involved in the business as more than passive investors would see 70 percent of their income classified as wages and taxed normally, and 30 percent taxed at the pass-through rate.

Also, the alternative minimum tax is repealed. The exemption for the estate and gift tax is doubled to $11 million and is then gradually abolished.

And a brand new 1.4 percent tax on university endowment income is added.

 

The bill still has to be scored and analyzed, first by outside groups like the Tax Policy Center and the right-leaning Tax Foundation, and then by the Congressional Budget Office and the Joint Committee on Taxation. Right now, the math seems to show really big, unworkable deficits; remember that bill will eventually be called due. What’s likely, then, is that this is an opening entry designed to pass the House and then be worked over, and shrunk in scale, in the Senate.

The legislation will face a lot of pressure to expand or protect certain cuts. Mortgage lenders and housing builders will push against limiting the mortgage interest deduction, blue-state Republicans will fight the limit on property tax deductions, and just about every business will fight for as much as they can get in corporate tax cuts and pass-through cuts (the fact that lobbying firms are organized as pass-throughs might mean trouble for the rule eliminating pass-through privileges for law firms). Social conservatives and anti-poverty campaigners will fight for a bigger child tax credit, available to more poor families. Seniors will fight for medical expense deductions.

All of that makes the bill more expensive, and harder to pass in the Senate.

 

Elsewhere, as expected, Trump nominated Jerome Powell to run the Federal Reserve once current Chair Janet Yellen’s term expires in February. Powell is currently a Fed governor, a moderate, he voted right in line with Yellen but is even less enthusiastic about regulation.

 

Tomorrow is a job’s report Friday. Look for a really big rebound from the 33,000 jobs lost in September.

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