If President Trump's tax reform proposal were to be implemented, it would bring the dawn of a new age for the bull market. I have no doubt that the S&P 500 (NYSEARCA:SPY) would soar to multiple new highs and achieve valuations that would rival, if not exceed, the peaks we saw in 2000 and 2007. The current price-to-earnings ratio, seen below, is already more than 25 times trailing 12-month earnings.
My bullish assessment of the President's tax plan has nothing to do with a strengthening of market or economic fundamentals. It is based solely on the fact that it would provide corporations and those Americans who already own most of the financial wealth with upwards of $600 billion in investable cash on an annual basis. This fiscal stimulus would fuel the purchase of risk assets in the same manner that monetary stimulus has since 2009. Again, it would be extraordinarily bullish for the stock market, but I suspect only over the short to intermediate term.
The reason that I put a time limit on the extension of the bull run is that eventually investors would realize that this tax reform plan was doing little to strengthen the foundation of our economy - the middle class. Instead, it would be weakening it, as markets digested the sugar high of additional liquidity.
This week Treasury Secretary Steve Mnuchin and economic advisor Gary Cohn, two former Goldman Sachs bankers, rolled out the simplistic bullet points of the President's new tax plan. Mnuchin asserted that it should be called the "2017 tax reform for economic growth and jobs to make America great again" plan. I call it something that isn't fit to print. There is nothing to substantiate that this plan would create jobs or lead to faster rates of economic growth. What it would do is fund stock buybacks and dividend payments, lift share prices and exacerbate the growing wealth divide between the uber-rich and everyone else.
While there are aspects of the plan that look appealing on a standalone basis, the devil is in the details. For example, the proposal to double the standard deduction to $24,000 for a couple's earnings may look enticing to members of the middle-class, but at the same time itemized deductions would be eliminated. The only exceptions would be mortgage interest and charitable giving. Depending on the number of children in the household and how many itemized deductions a family now claims, some will benefit while others will be worse off.
In a stealth move, the proposal eliminates the 3.8% tax on investment income, which is what is currently funding the Affordable Care Act. If you can't convince members of your own party to repeal the law, then just eliminate the funding for it. Placing the burden of soaring healthcare premiums on the millions of Americans who are currently benefiting from the Affordable Care Act will eliminate any benefit they might receive from the proposed tax cuts. These Americans would be much worse off.
Corporations and those who receive their income from pass-through entities like LLCs, such as myself, would have their tax rate lowered to 15% from what is now as high as 35%. The Alternative Minimum Tax and the estate tax would be eliminated. The more wealth and income you have, the more you would benefit from this plan.
If you give the uber-wealthy a tax break in the millions, they are not going to give their employees raises. Perhaps a handful might. They are not going to spend that new-found wealth on goods and services. Some might buy another home or a yacht, but most would invest the wealth instead.
If you give a large corporation a big tax break, it is not going to give its employees a raise either. It isn't going to invest in a new plant or equipment unless it realizes a significant increase in revenues from selling its goods and services that warrants the capital investment. Otherwise, it will return the new-found wealth to its shareholders or owners.
What leaves me mystified is that the President said during his campaign, as well as earlier this year, that "we will provide massive tax relief for the middle class." Yet the most generous analysis of the President's plan that I can find shows an increase of only 1-2% in disposable income for those who earn between $24,800 and $83,300. Is a few hundred dollars a year considered "massive" to you? I am wondering how long will it take the President's base of middle-class supporters to figure out that they have been duped? And once they do figure this out, how quickly will consumer confidence plunge? I expect this will happen before year-end.
Treasury Secretary Mnuchin claims that this tax plan will create millions of jobs and spur the economy to grow by 3%. This is absurd. Consumer spending on goods and services is what fuels our economic growth. Job creation is a result of that growth. If you want to stimulate growth through tax cuts, then put more money into the pockets of those who will either spend it on goods and services or pay down debt to improve their balance sheets so that they can spend on goods and services in the future.
The reason that the rate of economic growth was so weak in the first quarter of this year is that the rate of consumer spending growth has fallen to levels not seen since 2009. How can this be when the unemployment rate is so low and the stock market is at all-time highs? The reason is that real income for most American consumers has been declining on a year-over-year basis since the beginning of this year. These are the people who need a tax cut. If they can't spend, then the rate of economic growth will stall and job creation will slow significantly.
The worst aspect of this plan is that it increases the debt by approximately $6 trillion over the next 10 years, as our deficits would continue to grow. What happened to the fiscal responsibility that Trump railed about during the campaign? In order to pretend that the tax plan pays for itself, the Trump administration is making the bogus claim that its implementation will lift the rate of economic growth to 3%. A faster rate of economic growth will increase the tax revenue collected by the federal government, thereby paying for the tax cuts down the road. This might be achievable if what was being proposed was a massive tax cut for the middle class, but nothing could be further from the truth.
What this plan would undoubtedly do is lead to another leg up in the mountain chart below. It would leave our children with an insurmountable crisis that would accelerate the destruction of our social safety net.
We would also see our deficits rise significantly, which many on both sides of the aisle don't seem to think is an issue. It isn't an issue so long as the dollar remains the prominent reserve currency in the global economy and everyone else in the world is willing to lend to us.
The issue is that as our debt grows, our cost to service that debt increases, which slows the rate of economic growth. Any tax plan that doesn't address our long-term fiscal crisis, much less exacerbates it, is a horrible plan. Trump's tax reform plan will assuredly increase financial asset prices, and it might lead to a brief increase in the rate of economic growth, but it would be a disaster long term.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.