Trump Tax Plan Leaked, Includes Tax Cuts For Wealthiest Americans; Morgan Stanley Skeptical
Ahead of the Trump administration’s official disclosure of what its latest tax proposal would look like, overnight Axios leaked some of the more salient highlights, the first being that the tax rate for the wealthiest Americans would be cut to 35% and second, taxes on on big and small businesses would be reduced substantially, with plans to cut the top tax rate for “pass through” businesses from 39.6% to 25% – a move which would impact LLCs and sole-proprietorships. As Axios explains, this change would have a material impact on most small businesses in America, which do not pay the corporate tax and instead have their profits “passed through” to owners and taxed at the individual income rate. Bloomberg also adds that at the same time Republican negotiators are targeting a corporate tax rate of 20 percent, according to two people familiar with the matter. That would be higher than the 15% President Donald Trump wants, setting up a key decision for the president on a top legislative priority.
The plan was conceived by the “Big Six” Republicans, a group which includes House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Treasury secretary Steven Mnuchin, White House economic adviser Gary Cohn, and the chairmen of the two tax-writing committees — Senate Finance Committee chairman Orrin Hatch and House Ways and Means chairman Kevin Brady.
Some further details, per Axios’ sources:
- Top individual tax rate cut from 39.6 to 35. The current seven income tax brackets collapsed to three, as part of simplification. (Axios hasn’t obtained the other two rates.)
- Axios can confirm that the Big Six agreed to cut the corporate tax rate from 35 percent to 20 percent. That key detail leaked last night to the Washington Post. (Trump has said he wants the corporate rate to be 15 percent.)
- The Big Six framework is also expected to include guardrails to prevent wealthy people from artificially lowering their income taxes by rearranging their affairs to get taxed at the small business rate.
- We can confirm, too, WashPo’s reporting that under the Big Six framework there’ll only be three individual income tax brackets rather than the current seven, and that Republicans plan to double the standard deduction — a boost for the middle class and a key component of simplification.
As Axios adds, this “Big Six” tax framework “named because it’s been hashed out behind closed doors between six top Republicans and administration officials” will set up a clash with Democrats over the tax breaks that apply to large corporations and upper income Americans, as Democrats have already drawn a red line on tax reform and 45 out of 48 Democratic senators signed a letter saying they wouldn’t support any tax bill that adds to the deficit or offers new tax breaks to the wealthiest Americans.
At the same time, “republicans are desperate for a win and appear on course to fund tax cuts with a blend of deficit spending and the closing of loopholes. They will dare Democrats, especially the 10 senators up for re-election in states Trump won, to vote against tax breaks for their constituents.”
Trump and Treasury Secretary Steven Mnuchin have said previously that they didn’t want the tax plan to offer any tax cut to the highest earners and that they’d balance a rate cut by eliminating deductions that the wealthy use to reduce their tax bills. Mnuchin said in November, weeks after Trump’s election, that “there will be no absolute tax cut for the upper class.”
Reminded of that on Sunday, Mnuchin said he never made a “pledge” that there would be no absolute tax cut for the upper class in the administration’s tax plan. During an interview on CNN’s “State of the Union,” Mnuchin was asked about previous comments, in which he said there would be no absolute tax cut for the upper class.
“Can you reaffirm that pledge that there will be ‘no absolute tax cut for the upper class?” CNN’s Jake Tapper asked Mnuchin.
“It was never a promise. It was never a pledge…It was what the president’s objective was,” Mnuchin said. Mnuchin said the administration has been working with the bipartisan leadership.
“We look forward to releasing the plan this week,” Mnuchin said. “I think what’s important about this plan is it creates a middle-income tax cut. It makes businesses competitive and it creates jobs. That’s what this is all about.” Mnuchin also said there are “lots of changes” as it relates to the “high end.”
“We’re getting rid of lots of deductions,” he said. “And yes, I can tell you, the current plan for many, many people, it will not reduce taxes on the high end.” He also said the plan will provide a middle-income tax cut and said it will create jobs. Mnuchin also said that there was a meeting on tax reform on Tuesday at the White House with congressional Republicans and Democrats,
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Despite the growing movement on Trump’s tax reform, in a note released earlier this week, Morgan Stanley’s Michael Zezas said that he is skeptical of bipartisanship and Q4 is a logjam, “but tax reform should make slow progress toward 2018 passage even as failure risks remain. Deficit expansion is part of the deal, but limited in scope & stimulus.”
Below are Zezas’ observations on what happens next:
We expect the tax reform process to temporarily take a backseat to some legislative ‘must do’s’ in 4Q. The latest continuing resolution and debt ceiling suspension expire on December 8. A fix to the former is complicated by the need to raise expiring budget caps. On the latter, while cash-management measures should extend the ‘drop dead date’ on the debt ceiling until April (or, with a little luck, June), we believe Republicans will address this ‘early’, in 4Q, and include the debt ceiling increase in the end-of-year deal to avoid voting on it next year closer to the midterms while they are finalizing tax reform. December is further complicated by the Democrats’ declaration that they will include a DACA fix to all ‘must-pass’ legislation. We expect a face-saving resolution to emerge (potentially after a series of one-week extensions), but similar events have been volatility-inducing, historically.
Tax reform should survive, but advance more slowly than the current proposed timeline (1H18 passage est.). With data from historical tax cuts as our guide, we continue to expect a modest deficit expansion that delivers little near-term stimulus: We expect the tax reform effort to survive the pitched policy battles about immigration and near-term government funding. Republicans’ conceptual policy agreement on the issue, and desire to avoid squandering one-party control, likely supersede any lingering divisions and help the party continue its progress. However, some management of expectations regarding the timing and content of tax reform is in order, and outcome risks are skewed toward our bear case.
- Base case – a complex simplification: In our view, reconciliation limits the ambition of tax plans, and waters down even the less aggressive proposal we expect next week. Corporate reforms are phased in, with a terminal rate of 25% paid for by repatriation, haircuts to interest deduction, and dynamic scoring. Personal tax code changes include permanent ‘simplification’ and temporary, but modest, rate cuts paid for through dynamic effects and an income-based limitation of itemized deductions. First-year deficits would be projected to rise by a modest 0.5% of GDP, similar to the year 1 scores of the Bush tax cuts, given that currently proposed rate cuts score as similar deficit expansions.
- Bull case – all dessert, no vegetables: Holdout fiscal hawks abandon caution and fully embrace supply-side faith that tax cuts pay for themselves as special interest groups push back on initially proposed limitations to deductions. Corporate tax changes remain similar to the base case, but deficit-funded, temporary personal cuts are accommodated by either extending the budget window or replacing the JCT as the official legislative scorer. First-year deficits would be projected to expand by about 1% of GDP, the high end of the impact from recent, similarly sized, unfunded tax cuts.
- Bear case – party foul: No legislative action before the midterm elections as Republicans fail to clear any of a number of hurdles: key policy disagreements; delayed response to existing legislative needs like DACA or the debt ceiling; and an unforeseen crisis requiring Congressional attention.
Morgan Stanley concludes with the following five takeaways for Investors:
- Stimulus may disappoint, but progress is enough for risk markets near term;
- US dollar flow from repatriation may disappoint;
- Relative fundamental equity sector winners include retail, telecom, energy, & utilities;
- Tbills issuance may grow by $200B in 1Q18;
- Be prepared for Q4 volatility, opportunity.
In any case, President Trump plans to give a speech unveiling the Big Six framework in Indiana on Wednesday. The framework is the starting point for the tax reform process. It reflects the shared view of the Big Six, but it will inevitably change substantially as it goes through the normal legislative processes in the House and Senate.
Finally, going back to Axios, here are five things which it believes can trip the process.
- The National Federation of Independent Business (NFIB,) the leading small business association, wants to equalize the small business rate and the corporate rate. Under the current plan, that’s not happening. The corporate rate will be 20 percent and the small business rate 25 percent. “That’s going to be controversial, but it’s not a deal-breaker I don’t think,” said a source close to the process.
- House conservatives — especially the Freedom Caucus — haven’t been involved in the Big Six discussions and they want the corporate rate to be much lower, at 16 percent. Republican leaders say there’s no way that’s going to happen, and Treasury Secretary Mnuchin agrees.
The Trump tax plan will likely add to deficits, at least in the short term, which will bother some deficit hawks. But tax reform advocates were heartened when, just this week, Senate Republicans on the
- Budget Committee cut a deal that would reduce government revenue by as much as $1.5 trillion over 10 years. Republicans argue that, with economic growth spurred by the tax reform, there’ll be substantially less lost revenue than $1.5 trillion.
- Realtors and home builders won’t be happy with the doubling of the standard deduction. That’s because lots more people will take the standard deduction and many fewer will itemize their tax returns. A prevailing belief in the real estate world is that under those conditions, fewer people will take the mortgage interest deduction, which could mean fewer homes being purchased.
- Whichever groups are hit up for the “pay-fors” — the loopholes being closed — will inevitably form lobby groups and oppose those elements of the plan.