- Draft tax plans don't match Trump's promises, and suffer from poor optics
- Instead of an across-the-board cut, the current tax plan creates many losers
- While plans remain positive for USD, getting through Congress looks like a tougher challenge
Despite the significant opportunity to improve America’s tax code, the current House and Senate tax plans miss the mark for three big reasons. While expectations going into the event were high, disappointment is building as the tax plans are studied in broader detail. Beyond the obvious issue of significant differences between the House and Senate drafts, the suggested changes don’t match Trump’s earlier promises. On the campaign trail, Trump repeatedly criticized the country’s complex and high tax rates. While he avoided providing specific details, he promised big tax cuts for corporations and the middle class. In a recent White House event, he stated “We'll make the tax cuts simple and fair so that the vast majority of Americans can file their taxes on a single sheet of paper”. Far from “simple and fair”, both tax bills are so complex that most ordinary Americans won’t be able to understand how the proposed changes improve their lives.
Problem #1: Winners and losers
The biggest issue with both bills is that a significant portion of the population stands to lose if either proposal goes through. As Republicans have chosen to substantially rework the existing tax code, creating a significant number of losers is inevitable. The House plan which repeals large medical expenses is automatically unattractive for anyone facing the prospect of significant medical bills in the near future. Similarly, repealing the state and local tax deduction (even while allowing up to $10,000 of deductions on property taxes), will raise taxes for a number of middle-class and higher earners in states such as New York, New Jersey and California. Collapsing the number of tax brackets from seven to four also creates losers as lower income earners get pushed into higher tax brackets.
Instead of reworking the existing system, an across-the-board tax cut (especially targeted towards the lower and middle-classes) would have been far more politically feasible. Today, Trump’s clean message of substantial tax cuts is diluted after looking at the details of the existing proposals.
Problem #2: Uncertainty
The second issue is that the draft tax plans raise substantial uncertainty for many Americans. For those who have planned their finances (and lives) around existing deductions, the possibility of a sudden change in the future can be greatly upsetting. Voters expect Republicans to be ‘conservative’ in their decisions, and the party’s insistence on big changes is surprising. Far from ‘doing the right thing’, the proposal to repeal the state and local tax deduction looks like a declaration of war on liberals. This goes against Trump’s message of helping everyone get ahead in America, and is therefore problematic.
While big changes are sometimes necessary, Republicans could have chosen to implement the changes to existing deductions over an extended time period. For example, the state and local tax deduction could have been phased out over a 20 year period (with the deduction falling at the rate of 5% each year). This would have minimized any future uncertainty for everyday Americans.
Problem #3: Gaming the system
The last concern is that the current bill maintains deductions used by high earners such as the carried interest loophole (which reclassifies carried interest gains as capital gains instead of income) and the large mortgage interest deduction.
Trump promised to fix the current system which he called “rigged” by the elites. The continuation of both deductions suggests that the GOP is more responsive to elites (such as high earners and corporations) as opposed to the general electorate. While eliminating such deductions would rework the system, support for the carried interest loophole and the mortgage interest deduction for $1,000,000 mortgages is very limited among everyday Americans.
Tax plans and the US dollar
Earlier today, we lowered our medium-term outlook on the US dollar to neutral. The dollar sold off following the public release of both plans last Thursday, and bullish momentum appears to have stalled for now. Given the issues outlined above, there are growing doubts regarding the likelihood of the bill getting through Congress. As the proposed corporate tax cuts are more uniformly positive for American businesses, the dollar is likely to strengthen if the plans do get through Congress. However, this looks increasingly doubtful.
While optimism for tax cuts was driving the dollar in October and early November, policy support is no longer in the driver’s seat. Instead, future strength in the US dollar will have to come from economic strength. Thankfully, economic data remains strong. As we wrote in the past, the US dollar looks set to strengthen (despite the tax cut disappointment) thanks to the prospect of growth and inflation accelerating in tandem.