The Taxman

by: Invest With An Edge

By Jerry Wagner

George Harrison's shocking revelation still moves financial markets today!

Let me tell you how it will be
There's one for you, nineteen for me
'Cause I'm the taxman, yeah, I'm the taxman

Should five per cent appear too small
Be thankful I don't take it all
'Cause I'm the taxman, yeah, I'm the taxman

The Beatles' 1966 "Revolver" album began with George Harrison singing a composition of his that continues to resonate. Years later, Harrison recalled, "'Taxman' was when I first realized that even though we had started earning money, we were actually giving most of it away in taxes. It was and still is typical."

The 95% "super tax" that drove so many British music stars to leave the shores of Britain for the veritable tax haven of the U.S. has disappeared. Even America's top tax rate of 70% that greeted them has, thanks to Ronald Reagan, been eliminated.

It did not take long for the pressure to raise taxes to surface after Reagan. By the end of his first term, Reagan's successor, President Bush, caved and began the process of raising taxes. Despite the fact that it cost him the chance to serve a second term, the effort to raise taxes from Reagan's 28% max rate continued.

Don't ask me what I want it for
If you don't want to pay some more

'Cause I'm the taxman, yeah, I'm the taxman

By the end of President Obama's second term, the top tax rate plus the Obamacare surtax had crept up to over 42.8%, almost a 53% increase! With high state taxes in some states, many were once more paying over half of their earnings to governments in taxes.

If you drive a car, I'll tax the street
If you try to sit, I'll tax your seat
If you get too cold, I'll tax the heat
If you take a walk, I'll tax your feet

'Cause I'm the taxman, yeah, I'm the taxman

Late in life, Harrison was still complaining about taxes. Taxman was a regular part of his concerts. In 1991, during his tour in Japan, he and Eric Clapton combined for an updated version. In the rewrite, he lamented the value-added taxes (VAT) that were all the rage in Europe, eventually rhyming it with, "If you're overweight, I'll tax your fat."

Still, this week President Trump and a Republican Congress will attempt to stem the rising tide of taxation. At this writing, it appears that their effort will succeed. Certainly, the stock market believes this to be the case. Last week, equities gained ground once again, and today the market is soaring.

When we all awoke on the morning of November 9 last year, the possibility of the coming vote was suddenly thrust upon us. Whether you are for the tax cut or against it, there is no doubt that we would not be in this moment if there had been a different outcome to the presidential election.

The possibility of the now likely tax cut this week has propelled stocks into a rally that seems unstoppable. The S&P 500 has gained more than 24% since that November 2016 morning. Our Quantified STF Fund (MUTF:QSTFX) has soared more than 71% in the same period!

Now a little over a year later, we have to ask if all of the gains that the tax cuts are likely to generate are already priced into this market, or are there more gains to come? I believe it is the latter. I think a large share of the gains achieved so far are attributable to the improved regulatory environment for business ushered in by President Trump's election. There is a meaningful and palpable difference doing business post-2016. The stock market has been reflecting this.

Many are arguing "why now?" Why a tax cut now when the market is soaring and the economy is suddenly awakening from a period in which only sub-2% growth could be achieved? Won't the fiscal fuel of a tax cut cause the economy to overheat and generate inflation?

I think the answer is multifaceted. Yes, GDP is growing at a faster rate than in the Bush/Obama years, and the unemployment rate is at a new cycle low. But the labor participation rate is still near its lowest level ever, and wages have persistently failed to grow. Lack of investment has contributed to lower productivity, as well. All of these could stave off inflation concerns for a while.

A second, unspoken benefit of pushing the economy into overdrive, beyond the obvious electoral advantages for the Republican Party and President Trump, is the impact on Federal Reserve policy. Many are bemoaning the fact that this move will provide cover for the Fed to raise rates - and interest rates will most certainly rise if the cuts have their desired effect.

However, longtime readers of this column know that I have been saying that the real reason the Fed was so insistent on raising rates in 2015 and 2016, despite the slowest recessionary recovery in modern history, was to give the Fed the ability to reload.

The Fed desperately needs ammunition to fight the next recession. Higher interest rates now will give it the ability to use its number one recession-fighting tool - the power to lower rates - when the economy will need it most.

The Fed realizes, as I often say, that "risk is always with us." Yes, the economy has turned the corner. It will likely get even better when the tax reduction takes effect. But the good times are always followed by the bad times when it comes to national economies. The 2016 election did not repeal the business cycle. The Fed will one day need the policy bullets manufactured by this week's tax cuts, and we will be thankful that it has them.

Still, I view the signing of the tax-cut bill with some trepidation. "Buy the rumor and sell the news," goes the old Wall Street adage. Recently, I have been warning that a pause in the stock rally may be triggered by the actual realization of the tax-cutting dream of the president's supporters and most stock market participants since the election.

If this is to be the case, I do believe any pause will be relatively short and shallow. The economy seems too strong now for anything more than a technical correction (10%-15%). Recession fears are low, and the reality is that a recession seems distant.

Corporate earnings seem to get better with every new reporting period. Double-digit gains were recorded for the third quarter. They seem likely to reappear with the year-end reports that begin less than a month from now. As the tax cuts work into the system, these gains seem likely to further improve. Rallies in the stock market are fueled by these earnings.

Nevertheless, don't get too caught up in the tax-cutting celebration. And if markets do turn down for a bit, know that it's natural and is being monitored for action by our various strategies.

Remember too that we're just one election cycle from a whole new paradigm. The only certainties, we are told, are death and taxes. George Harrison once said of the "Taxman" that "it's a song that goes regardless if it's the sixties, seventies, eighties, or nineties. There's always a taxman."

I notice that the death tax was not eliminated in the final tax bill, as it was eventually killed for a short time in an earlier tax-cutting effort. I guess that's fitting, as the Beatles ended their song singing,

Now my advice for those who die
Declare the pennies on your eyes
'Cause I'm the taxman, yeah, I'm the taxman

And you're working for no one but me

Everyone here at Invest With An Edge joins me in wishing you a merry Christmas, happy holidays, and a healthy (and less-taxed) new year.

P.S. George Harrison was not the only one to rail against the taxman in song. Eleven years later, in 1977, Cheap Trick was obviously faced with a similar realization when they issued their own composition on the topic, with a nod to the Beatles. The song, which is on their first album, is called "Taxman, Mr. Thief":

You work hard, you make money
There ain't no one in the world who can stop you
You work hard, you went hungry
Now the taxman is out to get you
You worked hard
And slaved and slaved for years
Break your back, sweat a lot
Well, it's just not fair
He hates you, he loves money

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