It has been quite a week with far-flung influences impacting all asset classes. In the first instance, those include the U.S. tax reform announcement that in part had such a strong impact due to the Republican Senate and House and the Trump administration collaborating on something ahead of time instead of hoping their leadership would coalesce around a core idea. The lack of that same sort of coordination was at least partially responsible for the failure of the Republicans healthcare insurance reform efforts, and there are hopes that it will be different with the even more important tax reform effort. And those hopes were amply reflected in the strength of the U.S. equities and U.S. dollar as well while weighing on the govvies; all due to the prospect of greater growth from the further encouragement for individuals to spend tax savings and businesses is expected to invest.
While we cannot argue with a proposition that has proven true again and again from the Kennedy era onward, this particular tax reform proposal has some internal contradictions along with political hurdles that are greater than previous efforts. So there are pros and cons where the cons are either especially troubling or outright ploys. While we will get back to a more extensive discussion below, it is important to note the most contentious of the ‘streamlining’ proposals that also raises quite a bit of the revenue to fund the overall tax cuts is the elimination of state and local income tax deductions.
On one hand, this is a rational adjustment. On a politically conservative philosophical level as well as a practical consideration, why should the rest of the country underwrite the revenue collected by those local governments? It is a direct cost to the rest of the country in the form of the greater revenues collected from other states.
Senate the key… again
As with the healthcare reform effort, it is the Senate that is most interesting due to the far more marginal Republican majority compared to the House. Deductibility of state and local taxes from federal tax bills is seen as a cost that is centered in high tax, politically liberal Democratic states (like New York, California, Minnesota, Oregon, etc.) Yet there are some glaring exceptions that also impact Republican senators.
Thanks to the Tax Foundation for the opening graphic. © 2017 All Rights Reserved.
Let’s get away from the most glaring high tax states like New York at 8.82% and California at a whopping 13.3% and focus on some other states with still high state income tax rates around 6.0% or higher. We chose 6.0% as the important threshold due to the large number of states with roughly at least that level of state income tax, and how prominent the overall Republican Senate presence is in those states. There is also how much it would cost the federal government to allow that deduction to be maintained as they try to justify the cost of the tax cuts in other areas.