With the passage of the House’s tax reform bill, the Republicans have moved significantly closer to one of their key political goals. Of course, the Senate bill still needs to pass that chamber, and then the reconciled bill must pass both chambers. But the fact that the fractious Republican factions in the House have come together is a signal that passage is a real possibility. For the first time, in my opinion, the odds are now better than even. So, let’s take a look at what we know so far—and what these bills could mean for you.
Stock market perspective
First, corporate taxes will go down. We can argue over how much, but there is no doubt they will be lower. As investors, this is a good thing. The tax bills, if passed, will meaningfully increase earnings levels, which (other things being equal) will drive stock prices higher. It will also likely encourage companies with cash stashed abroad to repatriate it. This, in turn, will lead to buybacks and higher dividends, which could drive the market higher. From a stock market perspective, there is a lot of potential good news here.
From an economic perspective, the news is also good, although less so. Tax cuts put more money into the economy and are, therefore, stimulative. According to the analyses available so far, however, the bulk of the cuts will go to the more affluent, who are less likely to spend it. As such, the stimulative effects will be positive but perhaps less than expected. Much of the money is likely to be saved or invested, rather than spent. This would be positive for the financial markets but less so for the general economy.
The side effects
Besides the good news, we also need to consider the side effects. First among these is that, as written, the bills would result in substantial increases to the deficit. Indeed, the bills are bumping—by design—against a $1.5 trillion ceiling increase over the next decade. Much attention has been paid to how the bills are struggling to stay under that ceiling. Less attention has been paid to the fact that they increase the deficit by $1.5 trillion over that time period. If you were worried about the deficit before, you should be that much more worried now.
The argument against this is that the bills will lead to faster growth, which will solve the deficit problem by generating higher tax receipts. The problem? This has never worked in the past. Faster growth, yes, but not enough to offset the growth in the deficit.
Beyond that, another side effect is that the economic stimulus comes at a time when the economy is already running at close to full steam. To take only one concern here, where will the extra workers come from, with companies already reporting labor shortages? Economic stimulus is likely to help wage growth, which will be a benefit to lower-income tranches. But it will likely hurt corporate profits, as well as push up inflation and interest rates. With the Fed already showing a bias toward higher rates, that could crimp the financial markets and the economy in the medium term.
A mixed bag
Overall, the effects of the tax reform bills are likely to be mixed, especially when considered over time. Note that none of this analysis is about politics. It is math—or, at worst, economics—where we have to consider both the positive and the negative. Make no mistake, the tax reform bills will have positive effects, especially in the short term and especially for financial markets and investors. We should welcome those. We also, however, have to keep an eye out for the unintended side effects, which will show up over time.