InvestmentNews Editorials

Tax overhaul gift may turn into lump of coal sooner than later

Any positive effects are unlikely to last, and will contribute to greater budget deficits over the next 10 years

Jan 6, 2018 @ 6:00 am

The so-called Christmas gift given to the country by President Donald J. Trump and his Republican colleagues — the tax reform law — might be enjoyable in the short run, but it could prove to be nothing more than a lump of coal to many Americans over time.

The corporate and individual income tax cuts offered by the bill, signed into law by Mr. Trump on Dec. 22, might give the economy a short-term boost. But the positive effect is unlikely to last, and will contribute to greater budget deficits over the next 10 years, as the Republicans pretty much conceded throughout the drafting and passing of the bill.

The Congressional Budget Office estimates the income tax cuts would boost the deficit by $1.5 trillion over 10 years, and that doesn't even take into account the effect of rising interest rates on the already tremendous national debt of more than $20 trillion. The interest payments on that are estimated in the 2018 federal budget to total $332 billion, but will likely be higher as the Federal Reserve pushes up rates to prevent the economy from overheating.

(More: Your tax bill questions answered)

In just a few days after the passage of the tax reform bill, the 10-year Treasury yield increased to 2.47% from just under 2.35%, and 30-year rates increased to 2.86% from below 2.7% in mid-December. If that trend continues, it will increase the cost of refinancing the federal debt from current expected and budgeted levels as existing bonds mature.

And the $1.5 trillion to be added to the national debt does not take into account Mr. Trump's promised trillion-dollar infrastructure program for the nation's roads and airports.

The U.S. national debt is 74% of the nation's gross domestic product. That's better than some of our major trading partners, e.g., Germany (82%), the United Kingdom (89%), Canada (84%) and Japan (214%), but the new tax cuts are projected to increase that ratio to almost 100% within 10 years. That cannot be good for our competitive position in the world.

In addition, the new tax law preserved too many loopholes. It was supposed to be a tax reform bill, but the reform was at best half-done on the corporate side. Plowing through the 429-page bill, it is difficult to find significant corporate loopholes that were eliminated to pay for the corporate tax cuts.

There was a repeal of the deduction for local lobbying expenses. There was a repeal of the credit for testing expenses for drugs for rare illnesses. The credit for enhanced oil recovery and the credit for producing oil and gas from marginal wells were also repealed. There were various other repeals or modifications that only tax accountants could understand without referring to the previous tax code.

On the other hand, craft brewers, Broadway shows and citrus growers all received favorable treatment in the new tax law, and likely there were many others hidden in the legal verbiage.

Already analysts have noted some industries will benefit, while others will see their taxes go up. According to an analysis by the University of Pennsylvania's Penn Wharton Budget Model, the biggest tax savings will go to manufacturers — $261.5 billion between 2017 and 2018. That should be good for workers if U.S. manufacturers become more competitive in world markets.

Also gaining in reduced taxes are finance firms, insurance companies and retailers, while tech companies such as Apple, Google and Microsoft can bring profits stashed overseas back to the U.S. at a lower rate than in the past.

One of the negative side effects of all the horse trading that went on to get the tax bill passed was that investment portfolios will now have to be reviewed and likely changed. That involves increased research and trading costs for investors.

Tax law can distort corporate and individual investment decisions in both the long and short terms. Combined with the increase in the national debt, that lump of coal looks highly likely to be in our stockings by 2027.


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