Tax Reform 2018 Update 1

November 1, 2017 Tobin Smith

Odds now are @80% NO BILL by Year End

House Republicans chose to delay the release of the tax bill for at least one day for a very good reason; the "bill" is not a BILL yet and is not CLOSE to being ready for prime time.

THIS IS MAJOR LEGISLATION . . . and for major legislation to pass . . . the roll out is critical and... there IS NO ROLL OUT going smoothly with unresolved issues on the table.

The good news? Republicans are trying to maximize the growth effects of the tax cut and they realize immediate tax reductions are critical to goosing growth.

The bad news of course GOP lawmakers have now created a $3.5 trillion revenue shortfall and the MATH says they are short money for everything they want to do.

Reality: The least visible pain is embedded in the international component of the corporate tax bill and THAT IS WHERE most of that money has to come from.

Because the international component is complex lobbyists will be thick in DC. It also has to be accurately scored by the CBO.

All this reinforces our new base case that:

Passage is more likely to be 1Q 2018 than 4Q 2017 and
The package will HAVE TO BE smaller than the Framework envisioned to comply with Senate reconciliation rules.

Our base case is now:

23 percent corporate tax rate with strict rules for conversions to pass-through entities
3 years of 100 percent expensing
One-time repatriation tax change with a move to a territorial tax system for 2018 tax year going forward
Immediate (and retroactive) income tax cut and much higher thresholds for AMT and Estate tax but 39.6% rate stands for over $460,000 AGI married couple
Caps on state income tax deductions and no deduction for local Sales/Property tax

The "Oh Shit" Plan: The modifications are NOT fatal. Should large-scale reform fail, the House/Senate budget has created the flexibility that allows the GOP Congress to AT LEAST do a straight tax cut and blame Democrats for being obstructionists.

Caveat: We think too much optimism about tax reform is built into the market: The size of the 2017 U.S. non-inflation adjusted economy is north of $19-plus trillion. To move the economic needle:

"stimulus” has to be big to be meaningful enough to stimulate >1% additional GDP i.e., add >$200 BILLION in NEW economic activity; small moves are NOT going to work.

Of course public corporations are going use the vast majority of their $trillions in repatriated cash to

buy back stock
pay dividends
pay down non-convertible debt denominated in dollars
M&A

NOTE: There is NO SHORTAGE of cheap capital for mid-to-large corporations--there is a shortage of investment opportunities and end-demand.

Campaign season for the midterm elections is just around the corner. Those running for re-election want to tout tax cuts in their campaigns as an example of “bringing home the bacon” to their constituents and that Congress is slightly less dysfunctional.

The Wild Card: If last termer Trump Haters Senators Flake, McCain and Corker gang up or Rand Paul and Senator Susan Collins of Maine get jiggy ...watch out!

ACTION TO TAKE: To early to hedge...But if this slips to next week we will let the market tell us if they really care if it slips to 2018 AS LONG AS ITS RETROACTIVE.

- Toby