September 27, 2017

Stocks traded within a relatively narrow range yesterday.  Tech stocks, which were battered on Monday, stabilized.  Oil prices gave back a little ground after sharp rises in the wake of the hurricanes.  Interest rates crept upward, and the dollar continued its rebound.

Obamacare repeal and replace is now officially dead.  The Republicans have simply run out of time.  Multiple efforts to ram heavily flawed bills through on a purely partisan basis using reconciliation simply couldn’t get across the finish line.  Now they move to tax reform.  Later today, the President is expected to announce the outline of the plan agreed to by the White House and Republican leaders of Congress.  There are many steps still needed to pass tax reform, but at least Republican leadership starts out all on the same page.  The outline put forth today will be just that, an outline.  The details will be filled in by the tax writing panels in the Senate and House.  By Constitution, all tax legislation must begin in the House.  Before that can happen, however, the Republicans need to pass a budget outline setting the framework to allow them to pass a tax bill using the reconciliation process that needs only a simple majority vote in the Senate.  To do that, the bill must conform to the budget, and obviously, that can’t happen until there is a formal budget.

In many ways, tax reform will be a lot more difficult than repealing and replacing Obamacare.  Given the inability of Republicans to deliver on their pledge to overturn Obamacare, why should anyone have confidence that they will get tax reform done?  While the stock market seemed to favor companies that would be big beneficiaries of tax reform in the weeks after the election, price action since then suggests that markets are not counting on meaningful tax reform getting done.

But there are differences between repealing and replacing Obamacare and accomplishing tax reform.  Obamacare was the single most important legislation accomplished under the prior administration.  Forget for the moment its flaws, and there are many.  The idea that this law should simply be repealed is totally alien to any Democrat.  At the same time, and in part because it was passed on a purely partisan basis, Republicans hated the law from the start.  Hence, they have sought in many different ways to repeal it from the day it became law.  In other words, the obsession on both sides, one to retain it at all costs and the other to repeal it, overrode the merits of the law.  The basic tenets of the law to broaden healthcare coverage to all, to guarantee portability if one changed jobs, and to allow children to remain on parents’ policies to age 26 were admirable.  But while the law is formally called the Affordable Care Act, it is hard for anyone to define it as affordable.  Indeed, as constructed, it is a money pit.  Both sides see the flaws.  The private exchanges don’t work.  Premiums are rising faster than inflation.  The healthy young have no desire to subsidize the frail elderly.  Mandates don’t work and are poorly enforced.  One size fits all policies are grossly inefficient.

If politicians on both sides could get away with the black and white notions of either repeal or don’t repeal, they could focus on fixing what is wrong and keeping what works.  Someday that is exactly what will happen because left unchecked, premiums will get totally unaffordable and the exchanges will fall apart completely, leaving millions of Americans with no options at all.  Congress may not work well, but they do find ways to come together in time of crisis.  Even then they can be slow.

All this leads to the discussion of tax reform.  One only has to pick up a copy of the tax code and hold it in one’s hands to see its complexity.  Fixing it isn’t simple.  Actually, fixing it can be very simple, but we all know that it won’t happen politically.  But with tax reform, versus healthcare reform, there are several key differences.

  1. People on both sides of the aisle don’t like to pay taxes.
  2. Every smart person can be made to realize easily that deductions (the things I like) and loopholes (the things other people like that don’t help me) are terribly inefficient.
  3. Forcing businesses, jobs, and money to go overseas cannot possibly be good for our country and our economy.
  4. Preparing tax returns is overly complex and expensive.
  5. The world pays about 22% in taxes. Our corporate rate is 35%.  Where would you want to do business?

That’s where we all agree.  Here’s where we disagree.

  1. Should tax cuts be shared by all or should they be skewed toward lower and middle economic classes.
  2. Every deduction that is a prospect for elimination invites an army of lobbyists to protest. Members of Congress don’t want to be screamed at.  If they have strong backbones, they rarely show it.  The more deductions that are kept, the higher ultimate tax rates will remain.
  3. Cutting rates cuts tax revenue. Eliminating deductions raises revenue.  If rates are cut too far, growth may increase, but so will debt and deficits.  Some are willing to accept that hoping higher future growth will increase future revenues.  In 1986, when Reagan pushed through the last major tax reform package, that is exactly what happened.  The difference is that today our country has close to $20 trillion in debt.  How much higher should we be willing to go?

Thus, it comes down to who gets the most benefits, and how high will we allow the debt to swell.  Answer those two questions to the satisfaction of a majority and you have tax reform.  While Republicans are going to try and go it alone once again and seek to accomplish tax reform in the Senate using reconciliation, I don’t think it will be successful going down that path.  I simply do not think they are going to get 50 of 52 Republicans to agree on how far they will let debt levels grow.  Conservatives like Mike Lee, Ted Cruz and Rand Paul, just to name three, don’t want it to expand by a dime.  To satisfy them, Trump and his supporters will not be able to get the corporate tax rate anywhere near their 15-20% goal.  Thus, ultimately, Democrats have to be brought in.  There are several key Democrats up for election next year in conservative states like North Dakota and West Virginia that can enthusiastically support tax reform if the middle class base gets significant benefits.   In that regard, the Trump populist ideals and the ideals of centrist Democrats align pretty well.

In summary, I believe the best path to tax reform is bipartisan.  Sure, the Elizabeth Warren/Bernie Sanders crowd won’t go along, and the Republican opposition from the far right Freedom Caucus, who will want draconian spending cuts will have to be dealt with.  But tax reform is a cause for the majority center, a core that embraces both sides.  In the beginning, I expect Republicans to try and go it alone.  But fairly soon, they will likely see that path to be as difficult as the efforts to overturn Obamacare.  They may get close, but they may not get across the finish line.  The dynamic here is different.  Legislation starts in the House.  The first and most important battle will be with the Freedom Caucus.  We will see how that goes.  But if Republicans can’t do it alone, watch the President pivot quickly this time and start to embrace Democrats.  One thing is for sure.  The President and the Republicans need a win.  In politics, it’s the score that counts, not how you get there.

Last night, Roy Moore, a strident right wing conservative, won the runoff to be the Republican candidate in December for the election to replace Jeff Sessions as Senator from Alabama.  Also yesterday, Republican centrist Bob Corker of Tennessee announced he would not run for reelection in 2018.  This plays to my points on Monday regarding divisiveness.  The Supreme Court is scheduled to hear a case later in this session how Congressional districts are created.  They have previously banned the use of racial or religious profiling, but now they may rule on the merits of purely political profiling.  As things stand today, Republicans are getting more conservative and Democrats are becoming more liberal.  Extreme parties all over the world are getting more say shouting out the vast middle.  Change comes gradually.  Changing direction doesn’t happen easily.  Moore’s win and Corker’s resignation can’t be positives.

When you put a house up for sale and ask $800,000 and someone offers $200,000, nothing is going to happen.  But if the house is put up for sale at $525,000 and someone bids $475,000, a deal becomes much more likely.  I think it is fair to say that Bernie Sanders and Ted Cruz won’t agree on much.  That is not to say that both aren’t fine Senators.  But you can’t make laws with 50 Bernie Sanders and 50 Ted Cruz acolytes.  In the ideal, representation should properly represent the electorate.  That is part of our problem today; too many principled members of Congress unwilling to compromise and/or unwilling to listen to the other side.  Besides the complexity of tax reform, the makeup of Congress and the bad blood built up over 20 years suggests that odds of major tax reform are small.  One difference this time around, however, is that President Trump seems more invested in tax reform than he was in healthcare reform.  Now if only he can stay on message.

Today, Avril Lavigne is 33.  Gwyneth Paltrow is 45.  Meat Loaf is 70.

James M. Meyer, CFA 610-260-2220

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