Stock markets have boomed under President Trump. The Dow is up 25% since the election, passing 23,000 for the first time earlier this month. But serious tax reform is needed to keep things moving forward. Trump is all-in on making that happen, but Congress hasn’t delivered. Now, the president is putting serious pressure on Congress to pass the Trump tax plan.
This week, Treasury Secretary Steve Mnuchin told Politico that Congress needs to pass reform if it wants the stock market to keep growing:
“There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done … To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done you’re going to see a reversal of a significant amount of these gains.”
That statement was carefully crafted to give Congress a push. If tax reform fails–and economic growth slows down—President Trump will take some of the blame. But Congress will take more of it. Trump doesn’t face re-election until 2020. He has plenty of time to bounce back from any public backlash. By contrast, eight Republican senators and all 241 Republican representatives will face re-election in 2018. The clock is ticking.
The White House is turning up the heat. For its part, Senate Republicans are starting to respond. This week, Reuters reported the Senate is close to passing a budget resolution that includes a reconciliation clause. To make a long story short, reconciliation would allow the Senate to pass tax legislation with a simple majority. Otherwise, tax reform would require 60 votes, and Senate Republicans only control 52 seats.
The Trump Tax Plan
The president has been clear about what he wants to tax reform to look like. There are two key principles: lower rates and a simpler tax code.
It all starts with slashing the top income tax rate from 39.6% to 35%. Next, the Trump tax plan would abolish the federal estate tax and the 3.8% Net Investment Income Tax—the latter is an Obama-era tax that basically penalizes individual investors for earning investment income over $200,000.
Those things are good, but they’re marginal. Here’s the big baby: President Trump’s plan would slash the corporate tax rate from 35% to 15%. In addition, companies would only need to pay taxes on the profits they earn in the U.S. The idea is that lowering rates will give American companies less incentive to hide their profits overseas (as everyone knows, that’s a huge problem for the federal budget these days).
What it Means for Investors
By slashing rates across the board, Trump’s tax plan would put more money into the hands of households, corporations, and investment funds. That should turbocharge stock markets. Last month, two economists at the Royal Bank of Canada predicted the reform would add 0.5% to GDP each year.
Bank stocks would make out best from the tax plan. JPMorgan Chase (JPM), Wells Fargo (WFC), and Bank of America (BAC) would all earn significantly higher profits from the corporate tax cut. Also, smart investors are hunting for companies that currently pay the highest tax rates, expecting their stocks to take off.
There’s a downside, however. The Trump tax plan would add about $1.5 trillion to the national debt over the next decade. In order to keep the U.S. economy on strong footing, Congress will need to balance that with spending cuts. Spending cuts are historically more difficult to pass than tax cuts.
The short-term outlook is positive, however. Congress looks closer than ever to passing the most meaningful tax reform since 1986. If it delivers on the Trump tax plan, stock markets will really take off.