- Stocks Down as Tax Reform Questions Linger
- How Will Tuesday’s Election Impact GOP Agenda?
Stocks saw an eight-week winning streak broken this week, largely on questions surrounding tax reform. Stocks initially sold off sharply yesterday as headlines hit that the reduction of the corporate tax rate would be pushed to 2019. Corporate tax reform has helped drive stocks this year, although I’ve argued the market hasn’t priced in the entire benefit and that much of this years growth has been fueled by stronger economic growth and corporate earnings. For the week, the Dow declined 0.5% while the S&P 500 declined 0.2%.
Tax reform was a major focal point this week for a few reasons. The Senate released its tax plan which has some key differences with the House plan, most notably it pushes the reduction of the corporate income tax into 2019. Senate rules allow a simply majority vote for tax reform if the 10-yr deficit from the changes is less than $1.5 trillion. The CBO scored the House bill as having a $1.7 trillion cost, so pushing the corporate income tax out a year helps close the gap.
One of the things I find interesting about the CBO scores is how many variables are involved and how different the numbers can be with small changes in assumptions. The CBO has been using a 1.9% annualized growth rate. That’s essentially the average since 2000, so it’s not an unreasonable assumption. However, Republicans have argued that tax cuts, especially corporate tax cuts, can help growth approach or exceed 3%. If a 3% growth figure is used, which was the US average from 1946 to 1999, then the tax cuts can are significantly less expensive. You might hear people talking about static vs dynamic models and this is what they are talking about. In a static model, constant variables are used. In a dynamic model, analysts give future growth credit for changes in tax law. Dynamic models are much more complex and subjective, because analysts have to decide how much various changes will positively or negatively impact future economic growth. In theory though, they are better because they recognize policy changes impact future growth.
The other big issue with tax reform is the results of Tuesday’s election. The outcome in Washington and New Jersey doesn’t tell me much about the countries opinion on Trump and the Republican agenda. The Virginia governor race also doesn’t say much to me. Democrats have won four of the last five Gubernatorial races in VA and Obama and Hillary both easily won the state. The VA House of Delegates, however, is an interesting story. The Democrats took control for the first time since 1999 and many rural and suburban seats thought to be safely Republican either flipped or turned out very close. This is somewhat analogous to the 2009 Virginia election which foretold what would happen in the 2010 midterms when Republicans rode a wave to major national victories. It will be interesting to see how Republicans react to this election. In 2010, Democrats put aside their differences and passed Obamacare and other legislation before the midterms flipped the House majority. Will Republicans do the same and rush to push through legislation while they can, worried that Democrats have a very real chance to retake the US House next November? There’s been a lot of disagreement about tax reform among Republicans, but if they want to get something done, it seems they need to get it done soon while they still control both houses of Congress.
|10-yr Treasury (∆ in bps)||2.33||(1)||(12)|