As Good As It Gets?

Authored by Sven Henrich via NorthmanTrader.com,

So they got their tax cut done. In the middle of the night again no less, despite the vast majority of the American people not wanting it. The reason may simply be that the American public is not believing the false narratives that are being sold to them. And who can blame them? It starts at the top after all. When Donald Trump claims the tax plan would personally hurt him everyone knows that’s simply not true. And still his agents insists on defending the lie by lying some more.

So I had to ask, does truth still matter:

Does truth still matter?pic.twitter.com/7kAMGCPZWO

— Sven Henrich (@NorthmanTrader) December 19, 2017

The answer may not reveal itself for months to come.

US cooperations will see benefits to GAAP earnings and they will increase dividends and buybacks. All true. But they will not hire more or pay more. We already know this:

Watch a tax narrative die in mid question:
It"s all giggles for Cohn.
h/t @carlquintanilla pic.twitter.com/9zGWWnABQR

— Sven Henrich (@NorthmanTrader) November 14, 2017

And since none of these things have to do with organic business growth corporations will eventually face a situation where in the following years an unfavorable comparison will emerge as the artificial earnings benefits are priced in and then earnings growth will look to drag in comparison as the organic growth won’t make up for the artificial delta. Ironically then pressure for efficiency improvements will arise and companies will rightsize in the name of efficiency gains to make up the difference, i.e. layoffs. So ironically corporate tax cuts in the long term will do the opposite of what they were advertised to do. One can virtually see it coming. But hey. Party away.

Fact is the tax cuts will not pay for themselves and deficits will be gigantic and the US treasury is already set to sell $1.3 trillion in debt next year alone.

My general premise is that deficits will further explode once the economy slows as the tax base will have shrunk. Paul Ryan is already on the record wanting to cut social security and medicare benefits. And the AARP knows who will get hurt:

AARP comes out against the tax bill. They are "deeply concerned" this bill won"t leave US with enough $$ for Medicare and Medicaid. They also say the bill will "likely increase taxes" for many older Americans. #TaxBill pic.twitter.com/nC6gL4WzWY

— Heather Long (@byHeatherLong) December 19, 2017

Short term gain, long term pain, but the architects of this construct will be long gone enjoying their gains.

It’s been said that bull markets end on good news and in this regard this may be as good as it gets.

2017 will go down in history as a year where markets got everything beyond their wildest imagination:

The most liquidity injections by central banks ever. (Over $2 trillion). The loosest financial conditions in cycle history:

A Fed that promised a reduction in its balance sheet but actually only delivered noise:

Any time now. ???? pic.twitter.com/IECCKem1dm

— Sven Henrich (@NorthmanTrader) December 20, 2017

In addition markets got to enjoy solid earnings growth coming from weakness in the years before. Never mind that most of the price expansion was multiple expansion related:

Other factors favoring asset prices: Negative interest rates across the globe continued to force money into high risk assets (“pushing people“). Central banks such as the SNB kept buying billions of dollars of US stocks. Record inflows of passive ETF inflows chasing returns they can’t find elsewhere. The elimination of organic sellers as part of a normally functioning market place. Buybacks, while not at a record pace, still continuing with billions upon billions of dollars allocated to reduce the float of shares. None of it related to organic growth.

And hence the disconnect of asset valuations from the underlying economy is now larger than during previous market peaks:

My summation here: Things will never be better for bulls. The supply demand equation will never be tilted so uniformly in one direction as they are now.

The combined effect of what I summarized above has produced massive multiple expansion and the end of any corrective activity in markets accompanied by record volatility compression:

The elimination of any price discovery. And what this chart above shows in the macro we see in the daily price action every day: Gaps, ramps & camps with virtually no price discovery in between:

Every day:

This is hubris. It’s not rooted in an economic growth base to back up the valuation growth presumed going forward. And the technical dislocation is not sustainable and I maintain all these gaps will fill into 2018.

Has it gone farther than we expected? Sure. Once you remove sellers from a market who knows where it ends up.

After all we find ourselves in an environment where companies can reach $10 billion market caps in the blink of an eye based on absolutely nothing.

The very definition of a mania.

So when I asked the other day whether we are sitting on a generational opportunity to sell equities I meant this not as a facetious question. Now granted I can’t say whether we top here, today or next year.

After all we now have a president literally promising higher stock prices on twitter:

Stocks and the economy have a long way to go after the Tax Cut Bill is totally understood and appreciated in scope and size. Immediate expensing will have a big impact. Biggest Tax Cuts and Reform EVER passed. Enjoy, and create many beautiful JOBS!

— Donald J. Trump (@realDonaldTrump) December 19, 2017

Stock prices are now a matter of national security. The Fed views a sudden decline in asset prices as a threat to the economy and the president sees stock market levels, the poster child of widening wealth inequality in the population, as a benchmark of his presidency:

What hasn’t been priced in: Less looser financial conditions, less central bank liquidity, no more tax cut carrot. But perhaps more importantly? How sensitive will the consumer be to higher rates? I asked this question in Riddle me this.

Fact is consumers keep piling into debt while rates are rising:

And with rising rates come higher interest payments:

I trust you see the math problem there. Indeed the majority of Americans may find that the tax cut crumbs coming their way may go toward servicing their debt:

Perhaps that’s ok if unemployment stays low forever:

The unemployment chart however suggests that this is as good as it gets.

Treasury Forecasts Tax Reform Will Lead To Longest Period Without Recession In History

One week ago, in its latest assessment of the current state of tax reform in the aftermath of the Senate"s passage of the tax bill, Goldman analysts calculated that while growth impact from tax reform had increased fractionally to around 0.3% in 2018 and 2019 "reflecting the slightly larger amount of tax cuts in the Senate plan following revisions, and our expectations regarding the eventual compromise", it expected a very modest - if any - boost to US economic growth from tax reform.

Today, in a report prepared by the US Treasury - which as reminder is run by former Goldmanite Steven Mnuchin - and which was meant to bolster the case for the economic growth to be unleashed by the Trump tax cuts, and distract from the spike in deficit funding, the Treasury’s Office of Tax Policy (OTP) calculated that - somehow - the Senate"s version of tax cuts will result in 2.9% real GDP growth rate over 10 years.

This 2.9% GDP growth scenario compares to a baseline of previous Treasury projections of 2.2% GDP growth. Treasury "expects approximately half of this 0.7% increase in growth to come from changes to corporate taxation, while the other half is expected to come from changes to pass-through taxation and individual tax reform, as well as from a combination of regulatory reform, infrastructure development, and welfare reform as proposed in the Administration’s Fiscal Year 2018 budget."

This Treasury also claims that this 0.7% increase in growth results in an increase in tax revenues during the 10- year period of approximately $1.8 trillion.

And this is where the magic of fairy-tale forecasts comes in because adding this $1.8 trillion of incremental revenue to the static current law score of -$1.5 trillion results in total receipts over the 10-year window increasing by $300 billion.  In other words, the Trump tax cuts will not only not add to the deficit but will reduce debt by $300 billion, according to the Treasury.

Conveniently, the Treasury caveats that "these increased receipts are primarily collected in the last five years, as full expensing creates growth in early years but results in a deferral of collection of taxes."

It is unclear what is more ridiculous: that the propose gift to corporations will not only pay for itself but lead to a perpetual engine of trickle-down economic growth, one which has been refuted in every single instance in history, or that the Treasury expects the US economy to continue for another decade without a recession, which in 2027 result in an 18 year period of continuous growth since the last official recession ended in 2009, the longest period without a recession in history.

Of course, when the next recession hits no later than 2019 when the yield curve will be steeply negative and crushing the financial sector, government tax revenues will plunge leading to a blowout in government borrowing, forcing the Fed to launch QE4 as its monetization of the surging deficit will be critical in a world in which every other central bank will be dealing with its own issues at home.

As parting humor, the OTP notes the following:

We acknowledge that some economists predict different growth rates. OTP projects that at approximately 0.35% of incremental annual GDP growth, Treasury tax receipts would generate approximately $1 trillion of incremental revenue. Neither JCT nor Treasury has released a score showing increased tax receipts from the House plan, though we would not expect the results to be materially different.

We will be happy to revert to this post some time in 2027 when total US government debt is between $35 and $45 trillion, and when as the CBO correctly predicted, total US debt/GDP will be in its exponential phase.

The Treasury"s 1 page "analysis" is below (link):

Paul Craig Roberts Exposes "Plunder Capitalism"

Authored by Paul Craig Roberts,

I deplore the tax cut that has passed Congress. It is not an economic policy tax cut, and it has nothing whatsoever to do with supply-side economics. The entire purpose is to raise equity prices by providing equity owners with more capital gains and dividends.

In other words, it is legislation that makes equity owners richer, thus further polarizing society into a vast arena of poverty and near-poverty and the One Percent, or more precisely a fraction of the One Percent wallowing in billions of dollars. Unless our rulers can continue to control the explanations, the tax cut edges us closer to revolution resulting from complete distrust of government.

The current tax legislation drops the corporate tax rate to 20%. This means that global corporations registered in the US will be taxed at a lower income tax rate than a licensed practical nurse making $50,000 per year. The nurse, if single, faces in 2017 a 25% marginal tax rate on all income over $37,950.

A single person is taxed at a rate of 33% on all income above $191,651. 33% was the top tax rate extracted from medieval serfs, and approaches the tax rate on US 19th century slaves. Such an upper middle class income as $191,651 sounds extraordinary to most Americans, but it is so far from the multi-million dollar annual incomes of the rich as to be invisible. In America, it is the shrinking middle and upper middle class incomes that bear the burden of income taxation. The rich with their capital gains from their equity holdings are taxed at 15%.

Even single individuals who earn between $1 and $9,325 are taxed at 10% on their pittance.

The neoliberal economists who are the shills for the rich, Wall Street, and the Banks-Too-Big-Too-Fail claim, erroneously, that by cutting the corporate income tax rate to 20% all sorts of offshored profits will be brought back to the US and lead to a booming economy and higher wages.

This is absolute total nonsense. The money won’t come back, because it is invested abroad where labor costs are lower, if invested at all instead of buying back the corporation’s stock or buying other existing companies. After 20 years of offshoring US manufacturing and professional tradable skills and the incomes associated with the jobs, who is going to invest in America? The American population has no income with which to purchase the goods and services from new investment, and the American population’s credit cards are maxed out.

All that is going to happen is that Wall Street will calculate the lower tax rate into a higher equity price. Wall Street can do this without any of the offshored earnings coming home. Suddenly, everyone who owns equities will experience a boost in wealth, or the boost has already occurred in anticipation of the handout.

The deficit-conscious Republicans have put into the Bill for Enhancement of the Rich’s Wealth, cuts in social services in order to “save workers from higher interest rates from budget deficits.” This is more dishonesty. If the Fed lets real interest rates rise to any meaningful amount, derivatives will unwind, and the Fed will have to create trillions more in new dollars to keep its ponzi scheme in place. The deficit that results from the tax cut will be covered by the Fed purchasing the Treasuries, not by a rise in interest rates.

What we are witnessing in the US and indeed throughout the western world is the total failure of capitalism. Capitalism is now merely a looting machine. The financial sector no longer supplies capital for production. What the financial sector does is to turn discretionary consumer income into interest and fee payments to banks. Aggregate demand can only grow through debt expansion, and the consumers reach a point where they cannot expand their debt.

Capitalism, hiding behind “globalism,” which is misrepresented as a good thing when it is death itself, locates production where labor is cheapest, thus depriving First World labor of good wages and work opportunities and putting First World countries on the path to becoming Third World countries.

Short-term profits and executive and board bonuses and stock options are maximized at the cost of the destruction of the domestic consumer market.

Plunder Capitalism also privatizes as much of the public sector, such as the military, as possible, thus driving up the cost of the Pentagon’s budget. Jobs that the soldiers themselves formerly did are given to politically-connected firms. What was once KP (kitchen patrol) is now provided by an outside private service. Private mercenaries hired by the Pentagon collect as much in a month as troops in the line of fire earn in a year. I don’t know that the army any longer has a supply organization other than the private business that has the contract.

Medicare and Medicaid are the next to be privatized, along with Social Security. The tax cut will result in deficit and high interest rate hype, and these lies will be used to save the workers from high interest rates on their mortgage, credit card, and student loan debt by scaling back or privatizing Medicare, Medicaid, and Social Security.

The environment and public lands will be sacrificed to the private profits of timber, mining, and energy companies. Grizzly bears and wolves are losing their protection under the endangered species act so that states can sell trophy hunting licenses to men who have to prove their manhood by killing an animal with a high-powerful rifle at a safe distance.

What we are witnessing is the complete looting of America and the entirety of the West. While the Western World collapses, the insouciant, submissive people sit there sucking their thumbs while they are being ruined.

Nothing is left of the West except looters at work.

This tax bill is an abomination, an act of brutal plunder. Its sponsors should be tarred and feathered and ridden out of town on a rail, if not hung from a lamp post.

Corporate Tax Cuts: "The Seen & The Unseen"

Authored by 720Global"s Michael Lebowitz via RealInvestmentAdvice.com,

Since Donald Trump was elected President, the S&P 500 has rallied over 21% or nearly 500 points. In our opinion, a good portion of the gain is attributable to his promise, as well as congressional efforts, to reform the tax code. In particular, the proposed sharp reduction in the corporate tax rate has the equity market’s attention. At first blush, the simple logic driving equity investors appears reasonable.

Appearances, however, can be deceiving, and history is littered with failed investors that banked on a faulty thesis. As such, instead of tripping head first into that same category, we decided to assume nothing and look at the proposed reduction in the corporate tax rate and historical data to better understand how the legislation might affect the economy and corporate earnings.

Corporate Tax Rates

The graph below highlights the statutory and effective corporate tax rates since 1947.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

The statutory tax rate is the legally mandated rate at which corporate profits are taxed. As shown above, the rate has been consistent over the last 75 years except for one significant change as a result of the Tax Reform Act of 1986.

The effective corporate tax rate is the actual tax rate companies’ pay. One can think of the statutory rate as similar to the MSRP sticker price on a new car. It provides guidance on cost but consumers always pay something less. The effective tax rate, like the “discounted” price one pays for a car, is the actual percentage of profits that corporations remitted to the government. This rate is calculated by dividing a company’s tax payments by their pre-tax profit. Deductions of all sorts reduce the pre-tax profit, thus creating a difference between the statutory and effective tax base and therefore the amount paid. For purposes of this article, we aggregate corporate tax receipts and corporate profits to calculate an effective rate for all corporations.

From 1947 to 1986 the statutory corporate tax rate was 49% and the effective tax rate averaged 36.4% for a difference of 12.6%. From 1987 to present, after the statutory tax rate was reduced to 39%, the effective rate has averaged 28.1%, 10.9% lower than the statutory rate.

Based on this simple analysis thus far, it is easy to understand why equity investors are giddy over a sizeable reduction in the corporate tax rate. If the statutory rate is reduced to 20% as proposed, and the effective rate remains 10% lower, the amount of money corporations pay in taxes will be reduced sharply. Based solely on this assumption, corporate after-tax profits, in year one alone, should increase by almost $200 billion while federal corporate tax receipts will be reduced by the same amount. Such a boost in corporate earnings would increase the forecasted internal rate of return (IRR) on the S&P 500 by approximately .90%.  Holding everything else constant this equates to a price increase of 285 points for the S&P 500 or an 11% gain from today’s level. It is impossible to assess how much of the gain since the election is due to tax reform expectations and how much is due to other factors, but we wager a good portion of it has been based on the promise of tax reform.

History

While the math and logic above seem sound, we can turn to historical data to understand the relationship between taxes and economic growth and profits. In doing this, we can better forecast the actual effects that lower corporate taxes might have on economic growth and corporate profits.

The graph below compares the effective corporate tax rate to the running three-year average GDP growth rate. The dotted trend lines smooth the data to allow for a clearer comparison.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

As is clearly observable, GDP has trended lower at a very similar pace as the effective corporate tax rate. The graph below puts the data in a scatter plot format to evaluate the statistical relationship between corporate tax rates and economic growth rates.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

The R² shown above (.3552), a statistical measure of correlation, is far from perfect, but there is a reason to believe that lower effective tax rates may partially explain the weakening trend in GDP growth.  Based on statistical regression, every 1% decrease in the effective tax rate should diminish GDP growth by 0.12%. 

The President, his economic team, and lawmakers are selling the tax bill with claims that a reduction in corporate taxes will boost economic growth. Based on data from the last 75 years, that has never been the case. In fact, the average annualized GDP growth rate in the five years before the major statutory tax reduction in 1986 was 3.90%. In the five years following the tax cut, the average annualized growth was reduced by more than half to 1.93%.

Next, we show a scatter plot comparing effective tax rates to corporate profits.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

As measured by a R² of .051, the graph above shows that over the last 75 years, there has been no measurable relationship between effective corporate tax rates and corporate profit growth.

Who Pays

The historical evidence above tells a different story than the bill of goods being sold to citizens and investors.

 Corporate tax rates are positively correlated with economic growth which means that lower corporate tax rates equate to slower economic growth. Further, there is strong evidence that corporate profits are largely unaffected by tax rates.

Investors buying based on the benefits of the tax proposal appear shortsighted. They value the benefits of corporate tax cuts, but they are grossly negligent in recognizing how the tax cuts will be funded.  

The tax bill, as it is currently proposed, will increase the deficit by $1.5 trillion over ten years. As such, the government will borrow an additional $1.5 trillion on top of current projections of approximately $1 trillion per year.

When the government borrows money to fund a fiscal deficit they effectively crowd out investment that could have funded the real economy. Said differently, the money required to fund the government’s deficit cannot be invested in the pursuit of innovation, improving workers skills, or other investments that pay economic dividends in the future. As we have discussed on numerous occasions, productivity growth drives economic growth over the longer term. Therefore, a lack productivity growth slows economic growth and ultimately weighs on corporate earnings.

A second consideration is that the long-term trend lower in the effective corporate tax has also been funded in part with personal tax receipts. In 1947, total personal taxes receipts were about twice that of corporate tax receipts. Currently, they are about four times larger. The current tax reform bill continues this trend as individuals in aggregate will pay more in taxes.

As personal taxes increase, consumers who account for approximately 70% of economic activity, have less money to spend.

Summary

As is often the case in economics and investing, there is a “seen” and an “unseen.” The “seen” is widely visible and, right or wrong, generally represents a consensus agreement about reality. The “unseen,” while equally important, largely goes under-appreciated. In time, it is the “unseen” that will affect economic growth rates and corporate earnings. It is the “unseen” that investors must grasp if they are to be successful. In this case, the “unseen” is the massive federal deficit. Its burden on the economy prevents traditional forms of stimulus from having their desired effects.

Given the historical evidence regarding the implications of corporate tax cuts, we are left questioning the so-called “Trump bump.” We would argue that a market rally based on that premise is incoherent, and the market should be discounting prices and valuations due to the tax cuts not inflating them.

Goldman On Tax Reform: "Now Comes The Hard Part"

The ink wasn"t even dry yet on the just published Republican Tax Cut And Jobs Act, and within the hour UBS was already confident that it has virtually no chance of passing: As UBS chief economist Seth Carpenter wrote shortly after the publication, "to our read, the release confirms our view that tax reform is far from being a done deal. The bill contains several specifics that we believe will prove sticking points, which increase the difficulty of finding the votes to support the plan in both the House and the Senate." Fast forwarding to Carpenter"s conclusion: "We maintain our view that tax reform is unlikely this year or next."

To be sure, banks have a right to be skeptical: after all with the economy already growing above 3%, the last thing financial institutions want is for another burst of output courtesy of fiscal stimulus. Last week, Lloyd Blankfein said as much when the Goldman CEO warned "now’s not the best time for tax cuts", a view diametrically opposite that of his former "right hand man", Gary Cohn, currently Trump"s chief economic advisor, who said this is precisely the right time for more tax cuts.

“I can’t say this is the moment where you want the most fiscal stimulus in the market, when we’re mostly at full employment, when GDP last registered at 3 percent,” Blankfein said Thursday in a Bloomberg Television interview. “I don’t know that this is the moment that you provide the biggest stimulus.”

Goldman CEO"s skepticism was obvious in a report released this afternoon by economic Alec Phillips, who looked at the tax plan released on Friday, and said that while Goldman still assigns a two-thirds chance of tax reform passing, it conceded that "now comes the hard part."

First, here are the big picture details:

Tax Reform: Now Comes the Hard Part

• The recent release of the House tax reform bill marks the start of the second, harder, stage of tax reform. The plan cuts the corporate tax rate to 20% and reduces taxes on individual and “personal business” income while  staying within the $1.5 trillion (over 10 years) cost limit recently agreed to in the House and Senate. Achieving all three goals had appeared quite difficult in our view but the proposal does it, according to the official estimates.


• The House proposal includes substantial reforms. However, this greater-than-expected base broadening has already generated some political opposition, which is likely to lead to changes to the House bill as it moves forward.  The Senate is likely to release its own version with even greater differences within the next week or so, in our view.


• The proposed tax cut is more front-loaded than we have expected; official estimates suggest a tax cut of 0.75% of GDP in 2018. However, we expect the final version to have a smaller near-term effect as competing priorities lead tax-writers to phase in some cuts—particularly corporate rate cuts—over time. Senate Republican centrists have already expressed concerns about the cost and might balk at tax cuts that expire after five years, since the true ten- year fiscal cost would rise if they were extended.


• The net tax cut appears to be weighted more heavily toward individual and “pass-through” income than to the corporate sector. This is surprising considering the proposed immediate and permanent 20% corporate tax rate, but appears to be the result of substantial base-broadening, new restrictions on cross-border corporate activity, and the fact that several existing tax incentives are set to expire, which offsets a portion of the net tax cut under the legislation.


• We continue to believe that tax legislation has around a two-thirds chance of becoming law by early 2018. The release of the House legislation is a positive step in that it moves the process forward. It also demonstrates that  meaningful base-broadening might be more achievable than we have believed. However, it does not alter our outlook for the odds of enactment, since the Senate is likely to release its own bill shortly and the vote in that chamber represents the greater obstacle to passing tax reform.

Hatzius lays out the key underlying details for his current outlook:

There are good reasons to believe that tax legislation will become law in the next few months and we believe there is a 65% chance of enactment by Q1 2018. First, tax reform—and a net tax cut—is an area where the President and most congressional Republicans generally agree. This is notable, since there are substantial differences within the Republican Party on a number of other issues, including immigration, infrastructure, international trade and health reform.

 

Second, congressional Republicans face a difficult midterm election in 2018 and many lawmakers believe Republican prospects would be improved by a major legislative achievement before voters head to the polls. As Exhibit 1 shows, Republicans tend to be more supportive of most of the general aspects of tax reform than Democratic voters, though some tax changes are more popular than others; middle-class tax cuts and small-business relief enjoys broad support, while corporate tax cuts do not.

 

Third, tax legislation can pass in the Senate with only 51 votes, instead of the customary 60 votes, through the budget reconciliation process. Now that a majority of the House and Senate have passed a budget resolution calling for a tax cut of up to $1.5 trillion over ten years, the odds would seem low that they would fail to follow through in passing the tax legislation itself.

 

Nevertheless, there are still a number of ways that the effort could run off the rails. First, tax reform is much harder than tax cuts. The recently introduced House proposal is a case in point. While the proposal achieves meaningful reductions in individual and corporate tax rates, it also targets a number of specific tax benefits and several important constituencies have come out against the bill. This is the main risk to passing tax reform with only Republican votes, in light of the slim Republican majorities in both chambers.

 

Second, although House and Senate majorities voted in favor of a budget resolution including an instruction to cut taxes by up to $1.5 trillion over ten years, a few of these lawmakers have expressed some hesitation regarding the tax legislation itself. Senator McCain (R-AZ), for example, has called for the legislation to be considered under “regular order” and might not support a tax bill passed via the reconciliation process. Senator Corker (R-TN) supported the budget resolution but has left open the possibility that he would oppose the tax bill itself if he feels it would add to the deficit beyond the estimated revenue gain from economic growth effects and the cost of extending expiring provisions.

 

Third, while few argue against the concept of revenue neutral reform that lowers statutory tax rates and broadens the tax base, there are good arguments against a large net tax cut at the moment, including a high debt-to-GDP ratio, growing fiscal imbalances projected over the coming decade, and an economy with little remaining slack. This stands in contrast to the 1981 and 2001 tax cuts, when the federal budget was projected to run surpluses, the debt-to-GDP ratio stood at less than half of its current level, and the economy was in recession.

 

That said, the tax cut is not that large; nearly $500 billion in expiring tax provisions were likely to be extended regardless of tax reform, so the net revenue loss over ten years compared to our and most other realistic projections is only around $1 trillion (0.4% of GDP). The increase in GDP that would result from a tax cut would reduce the net cost slightly further.

Next, Phillips breaks down the key components of the Tax Cut And Jobs Act, whose core principles are summarized as follows:

On November 2, the House Ways and Means Committee released its Tax Cuts and Jobs Act (TCJA). The proposal makes more substantial changes than are implied by its estimated cost. The House plan achieves a 20% corporate tax rate and tax relief for individuals and “personal business income” while staying within the $1.5 trillion (over 10 years) limitation on cost recently agreed to in the House and Senate. Achieving all three goals had appeared quite difficult but the proposal managed to do this, according to estimates from the Joint Committee on Taxation (JCT); the most recent estimate puts the total revenue loss at just over $1.4 trillion over ten years.

Here, instead of repeating Goldman"s take on all the core aspects of the TCJA, we summarize the progression of tax reform courtesy of the following summary chart:

Which the brings us to Goldman"s critical discussion on "the way forward", or what happens next. Exhibit 8 below summarizes Goldman"s expectations regarding the timeline for consideration of tax reform over the next few months.

The House Ways and Means Committee is scheduled to begin its “mark up” of the TCJA on Monday, November 6. This is likely to take several days, and will involve the consideration of dozens (potentially over 100) amendments to the proposal, followed by a vote on the package as amended. House Republican leaders hope to pass the bill on the House floor the week of November 13, but might have to postpone the vote until after the Thanksgiving recess (the week of November 20) if there is insufficient support and further changes become necessary. In our view, there is little risk that the committee will fail to pass the bill, but a good chance that objections from some Republicans could delay passage by the full House until after Thanksgiving. That said, we believe there is a high probability of House passage by December.

How about the Senate?

The Senate Finance Committee might release its own proposal late in the week of November 6, though it is also quite possible this could be delayed. Although Senate Republican leaders have expressed hope that the Senate might be able to pass tax reform legislation by the end of November, this seems unlikely to us. Passage in December is certainly possible, however, in our view. We assume that a conference committee between the House and Senate will be necessary to resolve differences between the two bodies, which would probably delay final enactment until early 2018. That said, it is conceivable that the House could instead simply pass the Senate’s version of tax reform, which might allow for enactment before year-end. We continue to see enactment in early 2018 as the base case, though we note that market perceptions could shift substantially before then. For example, a successful Senate vote in December could lead market participants to place a high probability on eventual enactment, since the Senate vote is widely seen as the greatest risk to passage.

In summary, Goldman continues to believe there is a 65% chance that Congress will approve a tax bill by Q1 that results in a net tax cut of about $1 trillion (0.4% of GDP) over ten years (an amount similar to the tax cut under the TCJA, adjusting for scheduled expiration of tax incentives under current law) by Q1 2018. By comparison, prices in the online prediction market PredictIt imply a 60% probability that a corporate tax cut will be enacted by the end of Q1 2018, and around a 30% chance it would be enacted prior to year-end, down from over 80% early in the year.

What about the market?

The relative performance of our equity strategists’ basket of high tax stocks vs. the S&P 500 suggests that expectations have come down further. Even after adjusting for dollar depreciation—low tax stocks tend to have more foreign exposure so the relative performance might also be driven by the value of the dollar— the basket suggests that market expectations for tax reform that benefits high tax companies more than low-tax companies are not much greater now than they were prior to the election.

What may be taking place, according to Phillips, is that In light of the House proposal’s 20% rate combined with substantial base broadening and base-erosion protections, the market might soon assign a higher probability that the high tax rates faced by some companies— particularly those with a largely domestic focus— might converge with the low effective tax rates that some US-based multinationals pay. As a reminder, while the statutory US tax rate is 39%, the effective US tax rate of 27% has never been lower. In this light, the Trump tax cuts, contrary to Steven Mnuchin"s observations, will soon be seen as a non-event, especially if Goldman is correct, and the agreed upon corporate tax rate end up being 25%...

Stockman Slams Trump's "1500-Word Airball" Tax Plan

Authored by David Stockman via The Daily Reckoning,

The Donald’s strong point isn’t his grasp of policy detail.

The nine page bare-bones outline released this week is nothing more than an aspirational air ball that lacks virtually every policy detail needed to assess its impact and to price out its cost.

It promises to shrink the code to three rates (12%, 25%, 35%), for example. But it doesn’t say boo about where the brackets begin and end compared to current law.

Needless to say, a taxpayer with $50,000 of taxable income who is on the 15% marginal bracket today might wish to know whether he is in the new 12% or the new 25% bracket proposed by the White House. After all, it could change his tax bill by several thousand dollars.

Similarly, to help pay for upwards of $6 trillion of tax cuts over the next decade, it proposes to eliminate “most” itemized deductions. These “payfors” would in theory increase revenues by about $3 trillion.

Then again, the plan explicitly excludes the two biggest deductions — the charitable deduction and mortgage deduction — which together account for $1.3 trillion of that total.

And it doesn’t name a single item among the hundreds of deductions that account for another $1 trillion of current law revenue loss. They’re just mystery meat to be stealthily extracted during committee meetings after Congressman have run the gauntlet of lobbyists prowling the halls outside.

Stated differently, after nine months of work these geniuses have come up with $6 trillion of easy to propose tax rate cuts and virtually no plan whatsoever to pay for them.

In fact, this latest nine pages of puffery contains just 1,500 words — including obligatory quotes from the Donald and page titles.

I hate to get picky, but the Donald’s team has been on the job for 250 days now. And all they came up with amounts to just three words each per day in office.

Worse still, even as this “framework” opens the door to unrelenting demagoguery from the Dems about helping the rich, it does virtually nothing for Flyover America.

And it surely leaves the rust belt workers who voted for Trump in western Pennsylvania, industrial Ohio, the Michigan auto belt and the manufacturing centers of Wisconsin and Iowa with absolutely nothing to show for their efforts.

That’s right. There are 122 million tax filers in the U.S. (or 83% of the total) with AGI (adjusted gross income) under $100,000. And they would get essentially zero net cuts under the vague scheme presented Wednesday. Most pay virtually no Federal income tax anyway.

But you would never have guessed that the new nine-page plan is one big nothingburger for the bottom 83% of taxpayers based on the Donald’s oratory at Indianapolis yesterday. He essentially preached a storm in favor of the “little guy.”

That is, the Donald’s narrative was the same old threadbare story which claims the average worker is being crushed by Federal income tax payments and gets unfairly tangled up in the complexity of the IRS code without the benefit of high-priced tax lawyers and loophole-savvy financial advisors.

Accordingly, the Donald promised to “unrig” the tax code for these little guys, thereby keeping faith with the millions of dispossessed citizens of Flyover America who voted for him last November.

Except, except… the whole Indianapolis narrative is essentially nonsense.

This isn’t 1981 and there is no raging inflation and bracket creep propelling the middle class into tax tyranny. In fact, owing to indexing and large increases in the standard deduction and personal exemption over the last 35 years, the income tax has essentially morphed into a Rich Man’s Tax.

Stated differently, the Donald’s new tax reform airball promises to make filing with the IRS more palatable to rank and file America. Yet 101 million taxpayers (69%) have no exposure to the complexity of the IRS code at all. They owe virtually nothing.

And I mean nothing. Among the 148 million income tax filers, the bottom 53 million owed zero taxes in the most recent year (2014), and the bottom half (74 million) paid an aggregate total of just $45 billion.

So let me be very clear. There was still $4 trillion left in the collective pockets of these 122 million taxpayers — even after the IRS had its way with them!

By contrast, the top 4% or 6.2 million filers paid $802 billion in Federal income taxes. That amounted to nearly 58% of total Federal income tax payments.

Now, I do not object to putting some of that $802 billion back into the pockets of the top 4% — given that many of them are small businessmen and the proverbial “job-creators” who make the economy grow.

But incentivizing the job creators in this manner should not be financed on the backs of future taxpayers via borrowing. It must be paid for with spending cuts as a first resort, and less onerous taxes — such as consumption taxes.

Even if a Keynesian demand side tax cut was a good idea, which it isn’t, the fact is there is not much more that could be put “back in their pockets” by means of income tax cuts.

So the truth is, you could have scratched this so-called “framework” on a yellow pad in one hour on January 20 if you had even a general grasp of Trump’s vague campaign promises.

But had you stopped there you should have been promptly fired because in the form presented Wednesday the plan is a minefield of unanswered questions. It will tie the Congressional tax-writing process in knots for months to come — if not indefinitely.

Beyond that, there is another factor that shows why the Donald is barking up the wrong tax tree. The Fed has generated such gigantic financial bubbles and caused all financial assets to become so massively overvalued that incentives for the rich are not really in short supply.

Stated differently, Janet Yellen and the other Keynesian liberals on the Fed have generated more “trickle-down” wealth and rewards than the Gipper could ever have imagined back in 1981.

The $45 trillion in household wealth gains since the 2009 bottom — which has overwhelmingly accrued to the top tier of households which own most of the financial assets — vastly overshadows any possible benefits from lower tax rates, even at the top of the income ladder.

If the bottom 83% don’t pay much tax in the first place, and if the top 4% who pay most of the taxes are not to be indulged for social policy/equity purposes, what’s the point of the whole income tax cut charade?

In fact, that’s why after nine months the Trump tax plan is still a 1,500 word air ball.

What it actually amounts to is amateurish stumbling around the K-Street corridor where every single “loop-hole” that can’t be named will be shot down.

In all, this plan is so embarrassingly weak that Mnuchin and Cohn should be fired on the spot.

Yesterday also demonstrates why the casino is such a dangerous fantasy land. It rose to yet another all-time high Wednesday apparently on the back of a tax cut plan that is virtually guaranteed to eat itself alive on Capitol Hill.

The chickens are coming home to roost. Indeed, if such domestic fowl could fly Washington’s skies would soon be dark with them.

A Quarter Trillion Dollars In US Savings Was Just "Wiped Away"

As part of its historical revision to GDP, the BEA also had to adjust personal income and spending, with the full results released in today"s July report. What it revealed was striking: over the revised period, disposable personal income for US household was slashed cumulatively by over $120 billion to just under $14.4 trillion, while spending was revised higher by $105 billion, to just above $13.8 trillion. There were two immediate consequences of this result.

First, as the following table shows, while government pay has remained roughly flat over the past 3 years, growing in the mid-2% to mid 3% range, wages and salaries for private workers have been steadily declining as the blue line below shows, and after hitting a 4% Y/Y growth in February, wage growth has slumped to just 2.5% in June, the lowest since January 2014 when excluding the one-time sharp swoon observed at the end of 2016.

But a more troubling aspect of today"s revision is what the drop in income and burst in spending means for the average household"s bank account: following the latest annual revision, what until last month was a 5.5% personal saving rate was revised sharply lower as a result of the ongoing downward historical adjustment to personal income and upward adjustment to spending, to only 3.8%.

In dollar terms, this revision means that a quarter trillion dollars, or $226.3 billion, in savings was just "wiped away" from US households - if only in some computer deep in the bowels of the BEA buildings -  who as a result have that much less purchasing power, and following the revision the total personal saving in the US as calculated by the BEA is now down to only $546 billion, down from $791 billion before the revision.

This means that either households will have to incur this much incremental debt to continue on the previous spending "trendline", or a quarter trillion in potential growth from the future economy (recall 70% of US GDP is the result of consumer spending), has just been chopped off.

Source

Mauldin Warns The Next Recession May Be A Complete Reset Of All Asset Valuations

Authored by John Mauldin via MauldinEconomics.com,

Sometime this year, world public and private plus unfunded pensions will surpass $300 trillion. That is not even counting the $100 trillion in US government unfunded liabilities. Oops.

These obligations cannot be paid. A time is coming when the market and voters will realize this.

Will voters decide to tax “the rich” more? Will they increase their VAT rates and further slow growth? Will they reduce benefits? No matter what they decide, hard choices will bring political turmoil.

And that, of course, will mean market turmoil.

The Great Reset Will Cause a Horrible Global Recession

We are coming to a period I call “the Great Reset.” As it hits, we will have to deal, one way or another, with the largest twin bubbles in the history of the world. One of those bubbles is global debt, especially government debt. The other is the even larger bubble of government promises. The other is the even larger bubble of government promises.

History shows it is more than likely that the US will have a recession in the next few years. When it does come, it will likely blow the US government deficit up to $2 trillion a year.

Obama took eight years to run up a $10 trillion debt after the 2008 recession. It might take just five years after the next recession to run up the next $10 trillion.

Here is a chart my staff at Mauldin Economics created in late 2016 using Congressional Budget Office data. It shows what will happen in the next recession if revenues drop by the same percentage as they did in the last recession (without even counting likely higher expenditures this time).

Source: Mauldin Economics

And you can add the $1.3 trillion deficit in this chart to the more than $500 billion in off-budget debt—and add a higher interest rate expense as interest rates rise.

The catalyst could be a European recession that spills over into the US. Or it might be one triggered by US monetary and fiscal mistakes. Or a funding crisis in China, or an emerging-market meltdown.

Whatever the cause, the next recession will be just as global as the last one. And there will be more buildup of debt and more political and economic chaos.

It May Be a Complete Reset

The Great Reset will also bring an increase in volatility. And the correlation among asset classes will once again approach 1.0, as it did during 2008–2009.

If I’m right about the growing debt burden, the recovery from the next recession may be even slower than the last recovery has been. That is unless the recession is so deep that we have a complete reset of all asset valuations.

I don’t believe politicians and central banks will allow that. They will print and try to hold on as long as possible, thwarting any normal recovery, until markets force their hands.

But then, I can think of at least three or four ways that politicians and central bankers could react during the Great Reset. Each of the four ways will bring a different type of volatility and effect on valuations.

Flexibility will be critical to successful investing in the future.

I think the answer lies in diversifying among noncorrelated trading strategies that can invest in any asset class.

*  *  *

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Which US Region Contributes The Most To GDP?

The U.S. Bureau of Economic Analysis (BEA) has published gross domestic product (GDP) figures for the fourth quarter of 2016 by state. According to the BEA data released on Thursday, real GDP increased in every state and the District of Columbia for that time period.

GDP by state growth ranged from 3.4 percent in Texas to 0.1 percent in Kansas and Mississippi. Finance and insurance; retail trade; and professional, scientific, and technical services were the leading contributors to U.S. economic growth in the fourth quarter.

Overall, growth was pretty even when states are combined to regions. The GDP share of those regions didn"t change much, comparing year-over-year fourth quarter figures.

You will find more statistics at Statista

As shown in the Statista chart above, the GDP has a strong correlation with how many people live in those areas. It doesn’t come as much of a surprise that the Southeast, which has the combined population of 12 states, amounting to approximately 83 million (or a quarter of U.S. citizens), also has the biggest GDP share, standing at 21.4 percent of total GDP. The thinly populated Rocky Mountain area (12 million inhabitants) has a share of 3.4 percent of the GDP.

Goldman Pours Cold Water On Trump's Fiscal Stimulus Plan

Goldman Sachs" Chief US Political Economist Alec Phillips writes that tax reform faces a risk of failure, but tax cuts remain likely... in 2018 and investors need to stay realistic about the impact of fiscal stimulus.

President Trump’s campaign proposals initially raised expectations of several forms of fiscal stimulus, driving investor optimism on both infrastructure spending and various elements of tax reform. However, we expect only tax cuts to have a meaningful effect on growth over the next couple of years. Three risks are behind this view: tax reform failure, fiscal constraints, and delayed enactment.

Debates, delays, distractions

First, tax reform faces a real risk of failure. If Republicans pursue revenue-neutral tax reform, they are likely to encounter the same challenges they encountered in passing their health legislation. Inclusion of controversial proposals like the border-adjusted tax (BAT) or even the repeal of corporate interest expense deductibility, for example, could sink the effort. Views on these issues do not follow traditional party lines, which could easily lead to some Republican opposition (we have already seen significant opposition to the BAT, for example). With few if any Democratic lawmakers likely to vote for the tax bill, Republicans would need nearly unanimous support from their own party. Thus, while revenue-neutral tax reform might be preferable from a policy perspective, imposing this restriction would lower the odds of enactment by next year.

In light of the challenges tax reform faces, we believe that President Trump, who did not emphasize revenue-neutrality during the campaign, is likely to eventually endorse more limited reforms that result in a net tax cut. However, the size of such a cut would be limited by fiscal constraints; centrist Republican lawmakers seem especially likely to balk at large tax cuts that would eventually require deep spending cuts to maintain fiscal sustainability. Dynamic scoring and other budget accounting strategies might provide several hundred billion dollars’ worth of room for a tax cut in 10-year budget projections, but alone would allow for only a very modest cut. Our current expectation is a tax cut of $1.75tn over ten years, taking effect in 2018.

While Republican leaders have prognosticated that they might take the first vote on tax legislation as soon as May and enact a bill by August, the risk is skewed toward delays, in our view. Enactment of simple tax cuts should not take long—it took the Bush administration until only May to enact the 2001 cuts—but a lengthy debate over complex tax reform that ultimately fails could cause delays. Likewise, an effort to revive health legislation could also push the start of the tax debate to mid-year or later. And, while not directly related, fiscal deadlines such as the April 28 and September 30 expiration of spending authority and the debt limit deadline we expect between August and October are likely to distract from tax legislation.

A peek at the fiscal impact

We expect Congress to pass tax legislation sometime between 4Q2017 and 1Q2018. However, the potential fiscal impact is likely to become clear in the next couple of months, for two reasons. First, the White House is expected to submit a budget proposal to Congress in mid-May, and will need to clarify its intentions on the size of a tax cut at that point. Second, in order to pass tax legislation via the “reconciliation” process, Congress must first agree on a budget resolution providing instructions for the tax-writing committees to do so. These instructions must include a specific amount by which revenues should be reduced; once this figure is finalized, which we expect in May or June, a larger tax cut would not be possible without bipartisan support.

Holding out hope

While we expect the outlook for fiscal stimulus to become much clearer in the next couple of months, the consensus view is harder to discern. Our basket of high-tax stocks has given up all of its post-election relative gains (see pg. 10). That said, we believe the market consensus view is still for some tax legislation to pass. Prediction markets, for example, suggest around 60-70% odds of individual and corporate tax cuts being enacted this year. And the equity market continues to react negatively to perceived setbacks on tax reform, indicating that hopes of tax reform continue to be at least partly priced in.

A tax, not a spending story

Other forms of fiscal stimulus are likely to be fairly minor. The outlook on infrastructure is uncertain, and we expect changes to consist mainly of tax policies aimed at boosting private-sector activity rather than public spending. President Trump has also proposed a $54bn (0.3% of GDP) per year increase in defense spending, but we expect a smaller increase in overall net spending. One potential offset to the stimulus we expect is a reduction in subsidies under the Affordable Care Act (ACA), but our estimates assume no change in subsidies at this point.

The economic upshot

If fiscal policy plays out as we expect, the boost to growth would be worth around 0.3pp each in 2018 and 2019. The effects will likely be concentrated in 2018 but extend into 2019, as the policy changes will likely take more than one year to be fully reflected in the level of spending and tax receipts. All told, market participants anticipating fiscal stimulus will need to look farther out for the positive impact they expect.

US Government Revenues Suffer Biggest Drop Since The Financial Crisis

On the surface, today"s monthly budget statement was disappointing: in February the US Treasury brought in total receipts of $172 billion, versus outlays of $364 billion, resulting in a decicit of $192 billion, more than tha $190 billion expected (if in line with last year"s $192.6 billion deficit). For the fiscal year through Feb. 28, the total US budget deficit was $349 billion, virtually identical to the $351 billion deficit over the same period in 2016 and set to keep rising this year and for the foreseeable future.

On a 12 month run-rate, the US deficit stood at 3.1% of GDP. A year earlier, that figure was a third less, or 2.2%.

However, something more concerning emerges when looking at the annual change in the rolling 12 month total. It is here that we find that, like last month, in the LTM period ended Feb 28, total federal revenues, tracked as government receipts on the Treasury"s statement, were $3.275 trillion. This amount was 1.1% lower than the $3.31 trillion reported one year ago, and is the third consecutive month of annual receipt declines. This was the biggest drop since the summer of 2008. At the same time, government spending rose 3.8%.

Why is this important? Because as the chart below shows, every time since at least 1970 when government receipts have turned negative on an annual basis, the US was on the cusp of, or already in, a recession. Indicatively, the last time government receipts turned negative was in July of 2008.

One potential mitigating factor this time is that much of the collapse in receipts is due to a double digit % plunge in corporate income tax, which begs the question what are real corporate earnings? While we hear that EPS are rising, at least for IRS purposes, corporate America is in a recession.

How about that far more important indicator of overall US economic health, and biggest contributor to government revenue, individual income taxes? As of February, the YTD number was $611bn fractionally higher than the same period a year ago, and declining.

Finally should Trump proceed to cut tax rates without offsetting sources of government revenue, a recession - at least based on this indicator - is assured.

Barack Obama Is Now The Only President In History To Never Have A Year Of 3% GDP Growth

Following today"s extremely disappointing US GDP growth data, we have the final nail in the coffin of President Obama"s economic reign. Not only is the average annual growth rate of just 1.48% during Obama"s business cycle the weakest of any expansion since at least 1949, he has just become the only President to have not had even one year of 3% GDP growth.

An average annual GDP growth of 1.48% during Obama"s two terms...

As a reminder to a few blinkered media types, this means President Obama"s "recovery" has officially been the worst recovery in US history (despite adding almost $10 trillion to the national debt)...

And worse still, Barack Obama is the only president in US history to never have a year of economic growth over 3.0%...

As we noted previously, every other president in American history, even the really bad ones, had at least one year when U.S. GDP grew by at least 3 percent.  But this has not happened under Obama even though he has had two terms in the White House.

As a reminder, this dismal economic track record came at the same as President Obama almost doubled the National Debt...

When "fake news" and "peddling fiction" meet "alternative facts".