When the Trump administration unveiled the scant details of its tax plan at 1:30 p.m. in Washington, the Standard & Poor’s 500 stood at 2393.63, up from 2387.49 at the open. In the next few minutes the index moved up to 2397.44 as of 1:45 p.m. and then proceeded to fall until the market close. The index finished the day at 2387.45, just 0.05% lower than it began the day.
Why not a more positive reaction to the long-awaited tax plan from the President?
Three reasons I think.
First, there was simply too much going on today in Washington to anyone to pick apart what caused the market’s moves. We had leaks that the administration was preparing an executive order that would start the wheels rolling for the United States to pull out of the NAFTA trade deal with Mexico and Canada. (The Mexican peso and the Canadian Loonie both fell on the speculation.) And then there were rumors that House Republicans were looking to vote again on repealing and replacing Obamacare on Saturday.
Second, even if the proposal was the opening bid in a negotiation, it lacked crucial details need to assess whether this was a serious alternative to the tax plan introduced by Speaker of the House Paul Ryan. It’s impossible to tell at this point, for example, what impact the Trump plan would have on middle class taxpayers since while waving at lowering middle class taxes by increasing the individual exemption, it doesn’t specify the new level for the individual exemption. Without that it’s impossible to tell how much a middle-class family might save–if anything. Similar problems crop up with the proposal to cut the corporate tax rate to 15% from the current 35%. That cut would be available not just to corporations but to what are called “pass-through” entities. Anybody with a currently incorporated business and a decent accountant would use this loop hole put together a limited partnership to lower taxes to 15%. Trump advisors and Republicans in Congress have said that they can figure out a way to avoid individuals exploiting this loophole, which could cost the federal government an estimated $2 trillion in lost tax receipts over the next 10 years. But there’s no indication of a mechanism for doing so.
And that leads to the third reason for a lack of positive market reaction today.
Third, the plan doesn’t give any indication of how the administration proposes working around Congressional rules that would either doom this plan in any Senate vote or lead to the expiration of the tax cuts in as little as two years. To get around a likely Democratic filibuster in the Senate, Republican leaders in Congress would need to push through this plan under the rules for a Budget Reconciliation. That would allow the bill to pass with just 51 votes in a Senate chamber where Republicans control 52 seats. But to use that process, the bill would have to be revenue neutral, proposing enough cuts to spending or additions to revenue so that the tax changes would not add to the deficit at the end of 10 years. If the bill isn’t revenue neutral, its tax cut provisions would expire after 10 years or whenever the 10-year projections for the effects of those cuts led to a projected increase in the budget deficit over the ten-year period. Scoring of the Ryan tax cut plan, with its proposal to reduce corporate rates to 20%, showed that it would have to expire after just 3 years as it pushed the 10-year deficit higher after that point. Preliminary scoring of a reduction to 15% suggests that the Trump plan would have to expire even earlier, maybe after just 2 years. Unless, of course, the Ryan or Trump plan raised offsetting revenue or imposed offsetting spending cuts. Neither plan provides significant detail on offsetting revenue but at least the Ryan plan with its inclusion of a border adjustment tax, that is a tax on imports, does suggest a possible mechanism for generating offsetting revenue increases. The Trump plan doesn’t include a border adjustment tax and pretty much completely fails to address the issue of offsetting revenue. Even the proposal to end the federal deduction for state and local taxes doesn’t begin to generate enough revenue to make a dent in the deficit increase. (Oh, except that there have been efforts by Treasury Secretary Steve Mnuchin to argue that the tax cuts would generate so much additional economic growth that they would pay for themselves. I’m not even sure if any of the most extreme advocates of what’s called “dynamic scoring” believe that the cuts would generate enough growth to make up for revenue losses of the size proposed by the Trump administration. Not in a U.S. economy that is experiencing a slowdown in productivity.) So you can see why the financial markets, as much as they salivate at the idea of a cut in corporate taxes to 15%, aren’t quite willing yet to bake this plan into the prices they’re willing to pay for stocks.