At first glance, strictly from the point of view of the short-term impact they will have on the markets, what’s not to like about the Trump/Ryan/Republican tax proposals?
Trump is proposing a top corporate tax rate of 15% , and the Ryan plan essentially calls for 20%. The proposed corporate tax reduction will really have a far greater impact than any of the proposed personal income tax cuts.
The problem is that the devil is in the details.
Donald Trump
These are the details
Brady’s proposal includes a VAT-like tax along with a significantly reduced or eliminated corporate tax. It is possible that under his proposal an import duty would be levied on raw materials entering the country. That’s not clear. The main point is that they are still working on the details.
A 15% tax, combined with a VAT of some sort, could—but not necessarily would—be extraordinarily beneficial to the profits of US corporations. Some of Ryan’s proposals, which include a significant reduction in dividend and capital gains taxes, would also be bullish.
Some of the major proposals (even from Ryan) include a maximum tax of 25% on pass-through corporation income, which is the bulk of small-business income. That would be massively bullish for corporate profits.
Has the market gotten ahead of itself? I don’t know. Because I don’t know what is going to come out of the hodgepodge of tax and spending proposals we are seeing.
And this is the devil
A 20% tax/tariff on raw-material inputs would be massively inflationary. The United States simply doesn’t have the raw materials that it needs in order to produce the enormous variety of products that it does. The resources are simply not here.
For instance, we don’t have the right types of crude oil for all of our needs, and even if Trump opens up federal lands and makes it easier to drill for oil, it will take years—as in multiple years, longer than his first term—to get to the place where we are producing anywhere close to the amounts and types of crude that we actually need, if we ever can.
Further, many of our refineries are designed to take the heavier crudes that come from foreign imports rather than our own light crudes. We are talking multiple tens of billions, if not hundreds of billions, of dollars that will be needed for retooling our own refineries to process lighter crudes.
That cost will have to be passed on, or companies will go out of business and tens of thousands of jobs will be lost.
Where would we get enough lumber for building if we start taxing Canadian timber at the border? Off the top of my head, I can come up with a dozen critical raw inputs that would be significantly more costly if we put a 20% tariff on them.
Put that in your inflationary pipe and smoke it. And then try to trade around that! I am not even going to offer you a chart of what happens to equities during periods of rising inflation, other than to say that it’s really ugly.
But it’s not all bad
That being said, there are parts of the Brady corporate/VAT tax plan that are very appealing at first blush—assuming of course that somebody figures out that raw material inputs have to be dealt with in a different manner.
And the whole situation becomes more complex because of currency adjustments. And then you throw in a stronger dollar, and it gets more complex yet.
However, the Brady plan would offer strong incentives to foreign corporations to establish plants in the United States to produce whatever they normally sell here, which would create US jobs. That’s assuming that other countries don’t modify their own tax proposals in a kind of tax bidding war.
A chance to change for the better?
At the end of the day, call me a sceptical optimist. The oportunity is here to radically reshape the entire tax process.
Maybe, just maybe, the market is getting it right. A radical restructuring of business taxes could be an enormous boost to corporate profits, which would change the entire price-to-earnings equation in a positive manner. Which is why you need to be long today, but you need to be long with a strategy that says that when the facts change, you change, and that you have a clear eye on a direct path to the exit, if and when you need it.
The market is a voting machine, and every twist and turn will change its sentiment. So it’s wise to stay on your toes. Restructuring the tax system the wrong way would be devastating.
Trump and his talented team, along with Ryan, McConnell, Brady, and all the rest of the players, need to be very circumspect in how they talk about the details of their plans in public before they get them hashed out among themselves.
Markets hate uncertainty, and we could see the entire bull market blow up before we know half the details if stuff starts getting leaked that could be interpreted as damaging.
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