Why Should I Care About Tax Reform?

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Published by Taylor Financial Group

It seems that everywhere you turn, someone is talking about tax reform and its potential impact on the economy and the markets.  Regardless of your political leaning, there are important aspects of tax reform that you need to know, as investors should not over or under estimate the impact of tax reform on the economy and markets.  Moreover, until a final bill is signed into law, there will be a great deal of wrangling regarding what individual deductions stay as is, get trimmed or get cut.  With that said, here is some food for thought (gobble, gobble).

There is talk of limiting property taxes to $10,000 and only allowing them to be deducted on your principal residence, and mortgage interest can only be deducted for loans up to $500,000.  These two changes, or variations of these changes, will have a profound effect on the housing markets in high “cost of living” States, like New Jersey, New York and California.  I also see it having a profound effect on the second home market, except for the truly wealthy who do not need to (or already can’t) rely upon these deductions.

No more deductions for state and local taxes.  Again, this disproportionately effects these blue states who did not vote for Trump.  Indeed, of the ten states with the largest impact from this change, none of them voted for Trump.

It remains to be seen how the collapsing of the tax brackets and adjustments to the standard deduction and exemptions will affect each individual taxpayer.  Depending on your situation, it could be a net positive, neutral, or a loss.  One needs to run the numbers.

Selling a home will be getting more difficult and expensive, as there will be a dollar for dollar phase out of the $500,000 exclusion for a married couple who makes over $500,000, and they need to have lived in the home for the last five out of eight years.  Basically, no breaks for the wealthy here and no flipping houses!

The alternative minimum tax (AMT) will be eliminated.  Makes sense if there is true simplification of the tax code.

And pass through business income taxed at 25% generally will not help professionals, but may help other types of businesses.  Let’s see what happens here as this is very interesting.

Clearly, Trump is focused on assisting businesses to be more competitive, and trying to simplify the tax code for individuals a little bit.  He has been focused on businesses since he has been on the campaign trail, and his rhetoric and proposals reflect his focus.  I don’t believe that business tax relief should be at the expense of the individual taxpayer, but in any event, there are some good arguments as to why we should care about business tax relief.

Why is the timing of any tax reform bill important to the economy and the markets?  If tax reform is completed prior to year-end, consumers and corporations will understand the terms of the tax plan prior to year-end, and therefore may be favorably disposed to spend more “out of the gate” on January 1, 2018.  Conversely, if tax reform is delayed into 2018, consumers and corporations may take a “wait and see” approach and delay spending until the terms of tax reform are well known.  Such a delay in tax reform and thereby spending on both the consumer and corporate fronts could create a drag on corporate earnings and revenue for all or a part of 2018.

What benefits would corporate tax reform bring to the overall economy?  Currently, the US economy is constrained from a productivity standpoint.  Capital investment is necessary to substantially improve worker productivity.  If tax reform provides corporations with additional earnings and the ability to bring capital home that is currently held overseas, corporations will be in a better position financially to invest in staffing and infrastructure.  These capital investments should improve productivity and allow companies to better grow earnings and revenue.  Also, expect some corporations to issue one-time dividends and increase stock buybacks with a portion of the monies brought back from overseas.

Why would companies want to increase capital expenditures?  The labor market has tightened significantly since the great recession, with unemployment currently hovering around 4.1%.  More and more, companies are experiencing difficulties hiring qualified workers.  Therefore, companies should want to increase capital expenditures to improve productivity.  This increase in productivity should help keep labor costs in check by improving the productivity of their workforce.

What will be the fiscal impact of tax reform?  From a fiscal perspective, it is hard to justify tax reform for both corporations and individuals, as any tax reform will certainly increase the deficit and debt.  You may be hearing that tax reform will pay for itself by an increase in tax revenue, but this seems unlikely.  Currently, tax revenue is approximately 18% of GDP, with one more dollar of GDP increasing tax revenue by $0.18.  Therefore, you would need to achieve a fiscal multiplier of almost six for the additional tax revenue to cover any tax cut, which according to JP Morgan Chase, is very ambitious.

Please keep a lookout for future articles on this topic, especially once we have details on any bill that gets passed by Congress and signed into law.  Given that major changes are being considered, be prepared to sit down with your tax preparer or accountant to determine how these changes will impact your future tax bill.  As always, if you have any questions, please reach out to us!

 

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