Wall Street just had quite the week – both stocks and bitcoin swung up and swung down. Most of the seesawing was no doubt due to politics; last week brought the latest political sideshow in the Michael Flynn debacle. While spectacles like this may create economic ripples, we do best to keep our eyes on center stage, where the real magic happens.
Center stage these days means tax reform, which has the potential to significantly impact the economy and earnings. When it comes to tax reform, we are all eager to know, “Are we there yet? Are we there yet?” The answer is no. But, we are close.
My prediction was that tax reform would be in place by the first quarter of 2018, but the speed at which things are moving in Washington now makes it seem legislation could be passed by year-end. Senator John McCain helped usher in this new hope for resolution when he came out last week in support of the tax bill. Kaboom. The market was up over 300 points in a single day.
Overall, despite Friday’s dip, this past week was one of the best, if not the best, market weeks in 2017. It seems investors are now finally pricing the very real possibility that tax reform will get done, and soon.
Trending right along with stock market optimism is a downside of the proposed tax reform – the amount of misinformation out there about what the reform would do and what it wouldn’t do.
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If you have a creeping fear that tax reform will be bad for the economy and will only benefit the richest among us, you’re simply misinformed.
The reform is actually heavily weighted towards the middle class and could be a boon for the economy. But fear not; where there is misinformation, we can find an opportunity to become more keyed into realities and actual resultant scenarios, for you, for me, for the stock market and the economy.
An example of the effect of mass misinformation happened in 2015 and 2016. During this period, the prevailing zeitgeist (or “spirit of the times”) was that the economy was shaky, weak and crumbling. This feeling, which was bolstered by nearly all media outlets, turned out to be quite wrong.
If you believed this news, you probably didn’t invest. You probably ran from equities. There is, in fact, data that show the majority of investors have shifted away from stocks over the past decade.
So, if you bought into the prevailing message of previous years – a bad economy, bad markets ahead – then you have been left behind in a big way.
At the very least, you may have missed either all of or a big part of this past year’s rally. Over the past year (not year-to-date), the Dow is up 26%, the S&P 500 is up 20%, and the Nasdaq is up 30%.
Believing misinformation may have cost you, big time over the past couple of years. And, if you’re not careful, it could again.
My goal has always been to prevent folks from seeing the proverbial glass as half empty. Or, as our CIO Robert Sanders says, half broken. Here’s where the misinformation, or misleading and missing reports, are now. The media says the tax reform measure is really just a wolf in sheep’s clothing – a ruse designed to cut taxes on the rich while throwing scraps to the masses.
Okay, so arguably, in the beginning, a case could be made that this was true. The top tax bracket is slated to decrease from 39.6% to 35%. Small businesses are looking at a reduced tax of only 15%. And middle-income folks? They can expect to save a few hundred bucks a year at best. Even recent reports echo this millionaire-centric assessment of tax reform, stating that the highest paid people will take the lion’s share of cuts.
What’s important to remember is that this tax reform could result in cuts to the tune of $900 billion for individuals and $600 billion for businesses over a ten-year span. That’s not small potatoes and it’s not wishful thinking; that’s a very impactful and real number.
I work with plenty of folks who are in upper-income brackets. These folks have $500,000, $1 million, or $2 million a year in income. Much of this group could actually see a net tax increase.
When you take away the state and local tax deduction (SALT) and keep the top rate somewhere near 39.6%, this group has lost perhaps $100,000 to $200,000 in tax deductions. If you’re losing that much in deductions, even if the 39.6% rate doesn’t kick in until higher than previous tax levels, you’re still going to have a flat-to-higher tax bill.
So, the reporting on tax reform is wrong for a variety of reasons. A study by the Cato Institute, a libertarian think tank, helps put the proposed reform into a more accurate perspective.
Let’s take a look at the Cato study of the Senate tax plan.
The Cato analysis tries to “equalize” the new tax bill, meaning that it is a critical analysis without all of the political hoopla attached. Since the payroll tax and excise taxes aren’t up for a change in the bill, they take out that piece of taxation and look at what’s left. So, this study shows how the tax plan will impact specific income taxpayers based on tax brackets.
First of all, the $0 to $40,000 income group doesn’t get much of a tax break because they already don’t pay any federal income tax. Move on up to the $40,000 – $50,000 range, however, and the change is significant – there is a big reduction in federal taxes paid. In this bracket, the amount of federal income tax liability is slated to be reduced by 51%. That’s quite a reduction.
Move up to the next bracket, the $50,000 – $75,000 income range, and we see another reduction, this time for 24%. And the reductions don’t stop there. Here is a full rundown of the tax reductions we can expect, for each income bracket, under the proposed tax reform:
• $0 to $40,000 – stays at $0 in tax
• $40,000 – $50,000 – down 51%
• $50,000 – $75,000 – down 24%
• $75,000 – $100,000 – down 17%
• $100,000 – $200,000 – down 13.2%
• $200,000 – $500,000 – down 12.6%
• $500,000 – $1,000,000 – down 12%
• $1,000,000 and up – down 5.8%
• All taxpayers – down 12%
Now, these are projections from a libertarian think tank. But, what these numbers tell us is that the zeitgeist right now may very well be wrong. From the data, the idea that the tax cuts in the reform don’t help the middle class is just flat out wrong. The idea that the wealthy benefit the most is just wrong.
Some small business owners that will benefit, like those making between $400,000 to $500,000. But as for the small business owner in the $1.0 million to $2.0 million bracket, the deduction in the Senate bill only helps soften the first $500,000.
The takeaway here is don’t believe everything that you hear (or read, or are told). If tax reform does in fact happen, it will be a very big deal and could benefit the many instead of just the few. Not only would it usher in the changes outlined above, but we would see an increase in our paychecks starting January 1st. I don’t know anyone who wouldn’t like that.
Money Matters Radio: Tax Reform Is Not Just For The Wealthy