Tax Reform’s Impact On ETFs, Economy

December 06, 2017

After months of anticipation and political wrangling, tax reform is finally here. Well, not officially―the House of Representatives and Senate must come up with a compromise bill that can pass both chambers of Congress before President Trump can officially sign it into law. But if Republican leaders are right, they can come up with a consensus bill in time to pass it before the end of the year.

There are some key differences between the Senate and House bills that the conference committee tasked with coming up with a compromise must negotiate. For example, tax cuts for individuals would expire in 2025 under the Senate bill, but would remain permanent under the House bill. The Senate bill has seven tax brackets, while the House bill only has four. Under the Senate bill, corporate tax cuts don't go into effect until 2019, one year later than the House bill.

All those differences and others must be ironed out before the final bill can be passed. That means the ultimate form that tax reform takes is yet to be determined. Still, there's enough common ground between the Senate and House versions of the bill to make an assessment of how the law may impact the economy and markets.

Limited Growth Impact?

Economists and analysts are wasting no time in chiming in with their views. Professional economists are divided on whether economic growth will pick up meaningfully following the tax cuts. Many economic models suggest the growth impact won't be very large.

The Joint Committee on Taxation, a congressional group that investigates all things related to taxes, estimates the Senate version of the bill would lift gross domestic product by only 0.8% over the next 10 years, while increasing the deficit by $1 trillion.

Meanwhile, Goldman Sachs economists said this week that the tax cuts would have a meaningful near-term impact, lifting GDP by 0.3% in 2018 and 2019, but little to no impact beyond that.

Joe LaVorgna, chief economist at Natixis, agrees that the tax bill won't do much to accelerate growth. He told CNBC that "the reason it won't work is the corporate already has a very high profit share to GDP."

"That's not saying corporate tax rates shouldn't come down and there shouldn't be removal of loopholes. But to sell this as a stimulus package is absurd,” he added. “Companies have the money to spend; they're just not spending it. They're buying back stock. They'll do more of that."

Deficit Increase 'Drop In The Bucket'

Of course, the tax bill is not without its supporters, who believe reform can boost annual U.S. GDP growth from the 2.1% rate it has averaged since the financial crisis to 3% or more. Last month, 137 economists signed an open letter to Congress in support of tax reform, saying it will “ignite our economy with levels of growth not seen in generations."

One of those economists, Douglas Holtz-Eakin, former director of the Congressional Budget Office and president of the American Action Forum, told the New York Times the economic logic supporting the tax cuts is "straightforward and time-tested."

"Better incentives—like lower tax rates, being able to write off investments, taxation only on earnings in the U.S.—will encourage innovation, investment, hiring and pay raises,” he said. “These incentives increase the accumulation of capital, whether in physical equipment or intellectual know-how."

Holtz-Eakin also pushed against the idea that larger deficits due to the tax cuts will have much of an impact on the economy.

"The Treasury will need to finance another $40 billion to $60 billion more each year. This is a drop in the bucket of the Treasury market, with inconsequential implications for the overall level of interest rates," he explained.

 

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