Here's why Trump tax reform might not work as expected

Source: Business Insider

Whether you like Trump or not, the new administration is making some good things happen.

The combined impact of deregulation, tax cuts, and (possibly) infrastructure spending will push back against the Fed’s monetary tightening and keep the economy on roughly the same course as in 2017.

If the Republican tax bill isn’t what you wanted, join the club—I was a charter member as my Thoughts from the Frontline readers know.

The headline stories tend to look at the publicly traded giants. But the real impact will be on small and mid-sized businesses—particularly exporters and everyone who competes with imports. The lower tax rates will help them expand and even cut prices.

Having said that, the tax cuts won’t perform magic. I don’t expect uninterrupted 3% growth for the next decade, as some of the bill’s cheerleaders predict.

We will have another recession long before then, and it will probably be a deep one.

Businesses Will Once Again Game the System

I have been talking about the new law with senior financial executives of large, privately held companies, my own accountant, and a number of friends.

This is going to be like 1986 when everybody figured out how to game the system. You changed from being a C corp. to a sub-S corp.

When you look at Thomas Piketty’s fudged and manipulated US income numbers in his laborious and ill-conceived book Capital in the 21stCentury (which says something about economic academia), you see this massive spike in US income in 1986.

Did US citizens suddenly get rich? No, companies simply changed from being regular corporations to being pass-through corporations, which massively increased their reported income without actually increasing their real income.

I did the same thing. You were an idiot not to. Today we all use LLCs, and it is rare to see a sub-S corporation created today.

But now, you are going to see a lot of larger private pass-through corporations become regular C corporations again, because that’s how they can game the new tax system.

In addition, blue-state politicians are already discussing ways to alter their tax systems so that their residents can get around the new SALT deduction limits. The tax revenue that Congress thinks it's going to get is not all going to show up, so the deficit is actually going to be worse than projected.

The Tax System May Help in the Short Term

Goldman Sachs estimates the tax changes will boost GDP by an annualized 30 basis points in 2018–2019, then fade away.

That seems as reasonable guess as any. The changes will help keep the mild expansion alive and push back against Fed tightening, and I think Trump-driven regulatory easing should help as well.

Ask any CEO in practically any industry how much regulatory compliance costs—then stand well back. Now, if my friend GOP Rep. Jeb Hensarling can push through his reform of Dodd–Frank and ease regulations on small banks, we could see an even bigger boost.

Regulatory costs are a major expense item, and companies would much rather spend that money on other things like worker training and maybe even pay raises.

These same factors will also let public companies distribute more capital to shareholders via stock buybacks and dividends. That should support stock prices at least at current levels and possibly push them higher still.

It may not be another 2017-style record year, with numerous sectors gaining 20% or more, but it should be a decent year.

Notice that I said “should be.” Events could also conspire to derail that happy scenario.



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