President Trump and Congressional Republicans are about to unveil two, potentially market-moving measures: a tax overhaul plan and a new Federal Reserve Chair. As if those were not enough, those events will occur amid a Federal Reserve Open Market Committee meeting, a monthly jobs report and stock markets soaring to new highs.
Tax Plan Details: After months of speculation, Republicans are set to release details of their tax plan. Here are ten big questions that need to be addressed:
- What are the income levels to which the new tax brackets apply? To what range of income will the new brackets (12, 25 and 35 percent) apply. And with there be a new fourth rate will be added for income earned over $1,000,000?
- Will increase in standard deduction offset loss of personal exemption? The standard deduction would jump from the current $6,350 for individuals to $12K ($24K MFJ), so those who earn less would pay no taxes. BUT the plan also eliminates the personal exemption of $4,050 for taxpayers, spouses and dependents, which reduces taxable income. (The exemption phases out for single filers with AGI of $261,500 ($313,800 for MFJ). Larger middle class families may not see a reduction under the new plan may not fare well.
- What will the child tax credit be? The plan says that it would increase from $1,000 per child (limited to $75K for single filers, $100K MFJ) to an unspecified amount.
- Will the elimination of State and Local Tax (SALT) deductibility hold? Doing away with SALT would raise approximately $1 trillion. Republican lawmakers in high tax states like CA, NY and VA have argued that SALT deductibility must remain, at least for middle class homeowners.
- Will 401(k) deductibility remain in tact? After rumors swirled that Republicans were considering capping 401(k) deductibility at $2,400 (of the $18,000 maximum). Any additional amounts would be treated as Roth-like contributions, meaning that they would be taxed today, invested in a retirement account and then upon withdrawal, no tax would be due. Trump tweeted that the 401(k) would stay as is, but Mnuchin told the FT that because the deduction costs about $1.3 trillion over ten years, the administration would be willing to listen to Republican suggestions as to how to change some parts of 401(k) to raise revenue for the government.
- Will the Estate tax be repealed? One way to make up for lost revenue associated with repealing the estate tax is to also eliminate the “step-up in cost basis at death,” which allows taxpayers the ability to leave any asset to an heir at the date of death valuation, essentially erasing any capital gains tax liability. The estate tax repeal would impact less then one percent of taxpayers; step-up could impact 99 percent.
- In addition to a corporate tax cut from 35 to 20 percent, what will the rate be for repatriated corporate cash? A 2014 proposal called for 8.75 percent for cash and a lower rate for other assets, which could be paid over several years.
- Will there be limitations to pass-through Income? Income earned from S corps, partnerships, limited liability companies and sole proprietorships would be taxed at 25 percent. About 95 percent of businesses are structured as pass-throughs and they generate a majority of the government’s corporate tax revenue.
BALANCE SHEET/ECONOMIC IMPACT
- How much will the tax cut cost? The recently passed budget assumes that the tax plan could add an additional $1.5 trillion in debt over the next decade.
- What growth assumptions are factored in? Republicans say their plan would at least partly pay for itself by increasing economic growth.
Fed Chair: Janet Yellen’s four-year term as Fed chair ends 2/3/18 and President Trump has said that he will name a replacement as soon as this week. The finalists now appear to be current board member Jerome Powell and academic John Taylor. The case for Powell is straightforward: he is a Republican, though one who is closely aligned with the Bernanke/Yellen approach to monetary policy, meaning that he has favored a low interest rate environment to boost growth. He is also seen as more open to loosening financial regulation, which may be why Treasury Secretary Steven Mnuchin is a fan.
Taylor is an academic famous for his eponymous “Taylor Rule”, which prescribes a formulaic approach to setting interest rate policy. The rule suggests that rates should be much higher than they are now. Taylor has been a long-standing critic of the Fed’s interest rate policies and would move the central bank in a more hawkish direction, meaning that interest rates would rise faster than the current pace, potentially putting the stock market rally at risk, not to mention sow the seeds of the next recession. For those reasons, the betting markets are putting Powell as the likely choice.
The announcement of a Fed chair is likely to overshadow the Fed’s mid-week meeting. It is expected that the central bank will stay on the sidelines, though remains on track to raise rates at the December meeting.