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This guest commentary was written by Mike O'Rourke of JonesTrading. This piece was originally published on 8/23.

Tax Talk: Corporate Welfare & Budget Gimmickry - 04.26.2017 tax reform cartoon

The equity market started to bounce in typical fashion today, and once the bounces start, they don’t stop.  Thus the index rallied approximately 1%.  The optimism was largely attributed to media reports that the “Big 6” are making progress on Tax Reform, or more appropriately, Tax cuts. Politico reported that:

“President Donald Trump’s top aides and congressional leaders have made significant strides in shaping a tax overhaul, moving far beyond the six-paragraph framework pushed out in July that stoked fears about their ability to deliver on one of the GOP’s top priorities.

It appears the lofty principles surrounding generational Tax Reform are slowly being whittled away in favor Washington’s typical corporate welfare and budget gimmickry.  Bloomberg reported that the Republicans are seriously considering abandoning the standard “current law” baseline in favor of a “current policy” baseline that would allow $450 Billion in additional tax cuts.   

The “Big 6” consists of Gary Cohn and Steve Mnuchin representing the White House, Paul Ryan and Kevin Brady representing House Republicans, and Mitch McConnell and Orrin Hatch representing Senate Republicans.  The Politico story notes that the corporate tax rate will likely be cut to 20%-22% from the current level of 35%.

It appears the one decision that has been made is that “any tax proposal will require U.S. companies to bring back earnings from overseas at a one-time low tax rate, a favorite proposal of the business community known as repatriation.”  Repatriation has been considered an inevitable part of any tax legislation, but such a measure also requires that all of the loopholes be closed.  

For all of the President’s complaints about tax dodges, it is starting to appear as if he is hypocritically rewarding bad behavior.  In the weeks prior to the election, the NY Times published this Op-Ed highlighting the major US companies avoiding taxes since 2007.  Needless to the say, the five largest companies in the S&P 500 that have led this rally are on the list. 

Politico listed some of the prospective changes that are getting serious consideration as part of the new tax plan:

  • Capping the mortgage interest deduction for homeowners.
  • Scrapping people's ability to deduct state and local taxes.
  • Eliminating businesses' ability to deduct interest.
  • Phasing in so-called full expensing for small businesses that allows them to immediately deduct investments like new equipment or facilities.
  • Taxing the money that workers place into their 401(k) savings plans up front.

The only small business friendly measure on that list is “full expensing.”  While acknowledging these are only “reports” and they have very long road to travel before becoming policy, there does appear to be an imbalance.  It is hard to ignore that those specific options give the impression that the government is looking towards Main Street to pay for corporate tax cuts while rewarding the very corporations that have avoided taxes.  

As far as performance is concerned the names in the Overseas Cash thematic tracker who benefit from repatriation posted average gains of 1.14% today, slightly ahead of the broad tape (chart below).  Both the High Effective Tax Rate and Low Effective Tax Rate trackers performed similarly with approximate 1.3% average gains (charts below).

Tax Talk: Corporate Welfare & Budget Gimmickry - tax stocks

EDITOR'S NOTE

This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.

Tax Talk: Corporate Welfare & Budget Gimmickry - disclaimer