November 1, 2017

While our hearts and prayers are with those who suffered in the terrible tragedy in New York City yesterday, stocks move up and down on news that affects earnings and interest rates. Thus, as horrific as the events were yesterday afternoon, there is no linkage to financial markets. Instead this morning, markets are taking their cues from overseas, where stocks surged in Japan and followed through in Europe. As today is the first day of the month, we are likely to get a significant amount of economic news, starting with manufacturing data this morning. In front of Friday’s monthly employment report, ADP forecasts that October created about 235,000 net new jobs in the private sector. That would normally be considered a strong number, but it could be distorted this month by the effects of Hurricanes Harvey, Irma and Maria where some of the combined job losses of August and September were restored in October.

Besides the economic data, the House Ways and Means Committee will finally release details of its tax reform proposals tomorrow morning. The Senate should follow soon after. Republican leadership in both chambers of Congress, as well as the President, want everything signed and sealed by Christmas. That presumes a few things. First, it presumes Republicans in both chambers can stay unified such that their thin majorities can be translated into successful votes. As we saw with health care reform, that is far from certain. Second, it assumes the initial draft of the legislation doesn’t require all that much change. Tax reform is a mathematical puzzle. Based on the recently passed budget, any package that increases the deficit by more than $1.5 trillion over 10 years will require 60 votes in the Senate to pass. That isn’t going to happen. One certainty is that every deduction that the House proposes to eliminate will bring fierce opposition from Democrats and lobbyists. If the bill gives more tax breaks to the wealthy than the middle class, there will also be loud opposition from the same set of opponents, plus the liberal media. Polls could well show that the average American is against the package. With hindsight, Republican leadership didn’t do a very good job distilling a complicated health reform package into simple terms that the public could understand. All the public heard was how many fewer people would be covered under the proposed plan versus Obamacare.

With tax reform, it is the net difference that matters. I would be quite happy to see state tax deductibility disallowed if there were offsetting advantages (e.g. a lower upper tax bracket). The proposal is likely to double the standard deduction. That alone will make tax filing simpler for millions of Americans. The package will have goodies for everyone, and of course, some offsets. Not every single American is likely to end up paying lower taxes, but if total tax revenues, without the benefit of dynamic scoring, are going to go down over the next decade, the math suggests there will be more winners than losers.

The key, of course, is whether Republicans (there will be little or no Democratic support no matter what the bill says) can stand up to the collective outcries of Democrats, lobbyists, and the media. If polling suggests strong opposition, we all need to remember that individual members of Congress serve at the pleasure of their own constituents and are not beholden to party leadership or President Trump.

The reason tax reform has taken so long to pass (it took over two years during the Reagan administration) is that (1) it is complicated and (2) it takes a long time to educate everyone that the benefits outweigh the costs. The average American cannot relate to the notion of cutting corporate tax rates. They see that instinctively as a handout to their bosses, not them. They don’t see or understand that U.S. companies pay more taxes than anywhere else in the world, thereby driving both jobs and investment overseas. Similarly, they see repatriation of cash held overseas as a giveaway to stockholders. If, however, the repatriation could be tied to investment spending here or infrastructure repair, perhaps they would be more accepting.

The Republican agenda, however, basically gives three weeks to release the bill, hold a few hearings, make modest changes, and vote. In its efforts to reform healthcare, this rush to judgment allowed no time to educate. Education is more than a couple of talking heads spewing high-level language through the TV news channels. If Republicans insist on moving rapidly, they could find themselves in the same pickle as they experienced with healthcare, repeatedly trying to force a square peg into a round hole and trying to pass reform variants that had almost no media or public support. Mr. Trump, around the edges, still has the ability to modify healthcare regulations. He can’t, however, dictate tax reform via Executive Orders.

As a businessman, Trump is used to moving quickly. But Washington only works that way in times of extreme crisis. The most effective legislation has always been bipartisan and built with collaborative consensus. I am not suggesting that this time tax reform is going to be done with much Democratic support. It isn’t. But unifying Republicans won’t be a trivial task. The problems facing Republicans from New York will be different than the issues facing a Republican from Texas. Compromise requires some give and take. The reason the bill has taken this long to even be released is the attempt to find compromise just within the Republican block of the Ways and Means Committee. In my mind, a far more realistic goal, and one with a greater chance of success, would be to try and accomplish true reform within the first three months of 2018. More time won’t guarantee success, but it will allow for a better compromise. Congress still has a lot on its plate this calendar year, items that must be done before key deadlines. Markets today are optimistic about a package that clearly favors investors. By this weekend, however, we will see whether attitudes change after the vociferous opponents have their say in public and in the media. You can count on both.

Today, Jenny McCarthy is 45. Apple CEO Tim Cook is 57.

James M. Meyer, CFA 610-260-2220

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