Markets

Markets rally on hopes of Donald Trump’s tax cuts but what will they look like?

Really, it’s just too easy to make share markets sit up and salivate.

After last week’s turmoil – which culminated in the ousting of US President Donald Trump’s controversial chief strategist, Steven Bannon – investors had become despondent about the dysfunction and incompetence plaguing the White House.

The angst was so acute that Bridgewater’s Ray Dalio warned that the world’s biggest hedge fund manager was “reducing our risk” because of the likelihood that escalating economic and social conflicts will not be “handled well”.

“While I see no important economic risks on the horizon, I am concerned about growing internal and external conflict leading to impaired government efficiency (eg:¬†inabilities to pass legislation and set policies) and other conflicts”, he wrote.

But the Trump administration boasts several individuals with a keen, almost visceral understanding of financial markets.

Gary Cohn, Trump’s main economic adviser was previously was the second in command at Goldman Sachs¬†and US Treasury Secretary, Steven Mnuchin, is another former senior Goldman executive. Self-evidently, the best way to brighten the market’s mood was to raise the prospect of tax cuts.

Like Pavlov’s well-trained dogs, investors rushed to buy stocks on Tuesday night after Politico.com reported that Trump’s top aides (including Cohn and Mnuchin) and congressional leaders “had made significant strides in shaping a tax overhaul”, with a broad consensus emerging on how best to pay for the cuts in both individual and corporate tax rates.

These options include capping deductions for home mortgage interest payments, scrapping people’s ability to deduct state and local taxes, and eliminating companies’ ability to deduct interest.

There would also be a phase in of “full-expensing” for small businesses, which allows them to immediately deduct the cost of capital investments, including new equipment and facilities, from their tax bill.

In exchange the US corporate tax rate is likely to “fall to somewhere between 22 and 25 per cent” (depending on which tax breaks are eliminated or scaled back). Although this is well above the 15 per cent Trump favours, it is still a significant improvement on the 35 per cent company tax rate that US businesses face at present.

The report did note there were still some major differences left to resolve, such as whether the tax bill should add to the budget deficit, and whether the tax cuts should be permanent.

But it pointed out that Republicans are extremely eager to achieve tax reform because “it seems like their best and perhaps only route toward a major legislative victory before the fever of the 2018 midterm elections takes hold.”

But some analysts warn that the Republican lawmakers are extremely divided tax reform. Some argue that “full expensing” is an extremely expensive budgetary option, and are reluctant to antagonise their traditional big business backers by not allowing them to deduct interest payments from their tax bill. Conservatives in the House Freedom Caucus argue that the overwhelming priority should be to reduce the corporate tax rate below 20 per cent.

At the same time,m they point out that the tax reform process will be a huge political test of both Cohn and Mnuchin, neither of whom have a background in the complex area of tax policy, or with conservative Republican lawmakers.

And the pressure will be even greater given Bannon is likely to run an unrelentingly attack on both Cohn and Mnuchin – both of whom he derides as “globalists” – now that he has returned to his post as executive chairman of the right wing website Breitbart News.

Although Wall Street cheered Bannon’s departure, analysts point out that he did play an important liaison role between the White House and the conservative House Freedom Caucus.

As a result, his departure could make the complicated and painstaking process of tax reform even more fraught.

But these are issues for another day, and for the moment investors are pinning their hopes on the Trump administration’s ability to deliver a major tax overhaul.

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