For the number of headlines it generates and market jitters it causes, you’d think that the GOP tax reform plan would actually cut taxes on net. When chances of a bill passing look lower, stock indexes take a quick dive. When chances look higher, buying pressure resumes. In reality though, while tax reform may lower taxes for some, since it is designed to be revenue neutral, it will by definition raise taxes for others. There are no net tax cuts being considered, only a slight change in the tax burden from some groups to others.
Of course, investors may proceed by redirecting their capital toward sectors that will benefit if it passes. Select biotech leaders and the aerospace and defense industries may come out on top, but benefiting certain industries is a far cry from benefiting the U.S. economy as a whole, especially if tax reform is closely followed by higher tariffs against U.S. trading partners.
To whom is the tax burden being shifted exactly? Mostly to those in blue states, coincidentally or not, those whose electors went to Hillary Clinton this past election. How so? Tax deductions for local, state and property taxes will be capped at $10,000, according to the language of the bill, meaning those in high-tax states — mostly blue states — will pay much more federal taxes than before.
If tax reform were an across-the-board cut with across-the-board federal spending cuts to compensate, then Wall Street would have reason to cheer. But tax shifts like what is proposed in the new bill will only goad the economy into shifting capital investment rather than grow it as a whole.
But there are more reasons why the claim that tax reform will benefit the economy is a dubious one. As the Wall Street Journal points out, some small business owners would end up paying rates over 100% due to the convoluted structure of the specific overlapping reforms. This was obviously a mistake, but the point is if there’s one, there are others, and this is consistent with how the bill was passed through the Senate earlier in December.
The tax reform bill was initially passed with last-minute changes, including barely legible hand-written scribbles, with some pages crossed out with an X and others with just a line through them. Some Senators were unsure which pages were actually still part of the bill. They only had a few hours to go through the nearly 500-page legislation before they voted. Half-baked seems a polite term under these circumstances.
Even if we assume that the new tax structure will be beneficial to the economy overall somehow, we still know that deficits are projected to rise because spending is not being cut.
Structurally then, this is just more of the same tax shuffle game with stock prices being all too sensitive to its passage. Given current sentiment, if the bill passes both houses of Congress eventually, the resulting exuberant buying pressure could signal an intermediate top for the major stock indexes.