The dollar, and conservatives, are liking Trump’s tax proposal

BY DEB SHAW | 

  • Tax proposal looks like a good first step, with mostly positive reactions from Republicans
  • With 37 working days left for the House in 2017, a comprehensive tax overhaul is unlikely in 2018
  • Yet sentiment towards the dollar is extreme, and even a small win can help the currency change course

Trump’s ability to get laws passed through Congress has been his clear weakness. Despite Republican control of both the House and the Senate, the president has been unable to build enough support to deliver his election promises. Yet, skepticism towards his administration has entered extremes, and even a small win in an area like healthcare or tax reform can change the trajectory of expectations.

In our preview published earlier, we suggested that Trump’s tax reforms would look completely different from a conventional proposal. Specifically, we said that “Trump is likely to leave out many details in order to please a wide range of constituents. By doing so, the White House will have drafted a tax plan that has something for everyone – and one much more likely to get through a bipartisan process in Congress.” Looking at the nine-page document released yesterday, Trump appears to have followed our expectations.

 

First draft mostly matches expectations, with only a small number of surprises

The document released yesterday contains few surprises. As expected, the White House is proposing a substantial cut in corporate tax rates (down to 20%), while reducing small business taxes to 25% for S corporations or pass-through businesses. On the international front, the document has called for “taxing at a reduced rate on a global basis the foreign profits of US multinational corporations”, which suggests a lower rate on foreign earnings.

On the personal income side, Trump has proposed doubling the personal income deduction, while reducing the number of tax bands from seven to three. More interestingly the plan calls for eliminating most deductions, except charitable donations and home mortgage interest. The ultimate aim of the plan is to lower the burden on middle class families and corporations, while increasing taxes on the wealthiest Americans.

 

Initial reactions mostly positive, with wide ranging support from conservatives

Early news reports suggest that the plan was praised by a wide range of Republicans. According to an article on The Hill, the bill has backing from even the most right-wing conservatives from the Freedom Caucus alongside more traditional Republicans.

That being said, the proposal has its detractors. Democratic leader Chuck Schumer and several liberal politicians have criticized the bill, calling it “wealth-fare”. Unlike the debt ceiling issue, Trump did not consult senior Democrats prior to publishing his latest tax proposal. Schumer has also predicted that the bill will fail like reforms to healthcare, as Republican lawmakers would be pressured to vote against the bill if it harms their middle class constituents via increased taxes.  

 

Comprehensive tax overhaul doubtful, but that’s not necessary for a stronger dollar

Previous efforts to reform taxes, such as the Kennedy/Johnson tax cuts of 1964 or the Reagan tax cuts of 1986, took years of negotiations to come to fruition. Given the 2018 deadline to pass tax reforms (prior to the upcoming elections), there are only 37 working days left for the House to pass any new laws. The current proposal is a good first step, but remains a draft. If historical precedent is any guide, then hoping for comprehensive tax reforms by 2018 seems like wishful thinking.

That being said, investor sentiment towards the dollar is at such extremes that even a marginal win on taxes can power the currency higher. Looking back at recent history, the 2004 Corporate Repatriation Tax Amnesty (which allowed corporations to repatriate profits for a one-time tax of 5.25%), was widely credited for the US dollar bull market that took place in 2005. The US dollar index proceeded to rally by about 10% in 2005.

Despite the low likelihood of comprehensive tax reform in time for the 2018 elections, our view remains that even minimal progress on the tax front can have a substantial impact on the value of the dollar. Whether or not the dollar can stage a longer-term rally remains to be seen.   

Topics: US dollar
Tags: Trump