Congress Returns with a Full Agenda: What to Watch for in the Markets

Congress returns to Washington in June with only seven weeks to work before leaving again for the August recess. Below we consider what Congress is likely to accomplish, and how its actions (or inactions) are likely to affect the markets over the summer and into the fall.

Following are the immediate actions on Congress’ plate:

  • Debt Ceiling Increase: In mid-March this year, total federal government borrowing reached the limit authorized by Congress. Since then, the government, unable to borrow, has limped along using tax receipts and money in accounts it does not need right away. But tax receipts this year have slowed, as investors are putting off recognizing gains in anticipation of lower tax rates next year. To avoid a potential default on U.S. debt, Treasury Secretary Mnuchin has asked Congress to raise the debt ceiling before leaving for its August recess. Under the Senate filibuster rules, 60 votes are required to pass legislation raising the debt ceiling. Because the Republicans hold 52 Senate seats, Democratic support is needed. Many Republicans want to add riders to the debt ceiling bill that curb future spending and the permissible uses of borrowed funds. Democrats, in contrast, want a “clean” bill that raises the ceiling without condition. Ultimately, Congress almost certainly will raise the debt ceiling to avoid a national default, but getting there could be messy.
  • Government Funding:Congress has funded the federal government through September 30, the end of the current fiscal year. To avoid a government shutdown on October 1, Congress must appropriate additional funds to run the government before that date. Like legislation to increase the debt ceiling, funding legislation requires 60 votes in the Senate to overcome a filibuster. Thus, some Democratic support will be necessary. Republicans are calling for increases in military spending and deep cuts in domestic spending. President Trump also is demanding funds to build a wall on the U.S.-Mexican border. Democrats have indicated they will oppose these objectives. Reaching a compromise will require serious effort. We see a short-term government shutdown in early October as a distinct possibility.
  • Health Care Reform: The Senate is set to begin consideration of the House-passed American Health Care Act (AHCA), the Republican alternative to the Affordable Care Act (ACA, or Obamacare). Procedural rules permit Senate Republicans to pass much of the AHCA with a simple majority, so (unlike for the debt ceiling and funding legislation discussed above) Democratic support is not required. Nonetheless, forging agreement among the Republican factions will be difficult. As a whole, Republicans in the Senate are more moderate than their House counterparts. Republican Senators are concerned that the AHCA is projected to impose cost-prohibitive premium increases on some Americans with pre-existing health conditions while also forcing millions of poor families off the health insurance rolls. Finding a legislative solution that threads the needle between House conservatives and Senate moderates might be a bridge too far.
  • Tax Reform:Businesses are eagerly awaiting the passage of tax reform legislation that will simplify the tax code and reduce tax rates. Procedural rules permit Senate Republicans to pass tax legislation with a simple majority. Thus, Republicans are free to fashion tax legislation without concern about garnering Democratic support. But passage of sweeping reform legislation still is no easy task. Most legislators insist that tax reform not reduce significantly the revenue the government derives from the tax system. Most observers believe that reform can achieve this “revenue neutrality” only by joining lower tax rates with a broadened tax base, achieved by eliminating or curtailing existing deductions and exemptions. But every deduction and exemption provides a benefit to a particular group or economic sector. Once a tax bill identifies a deduction or exemption as a candidate for change, industries adversely affected push back strenuously, threatening Congress’ will to enact reform.

Market Reaction

The markets reacted excitedly to President Trump’s election victory last November, anticipating that the new Administration’s initiatives – fiscal stimulus, business tax reform, and reduced federal regulation – would boost economic growth and corporate profits. But, as Congress has failed to pass significant legislation during the first five months of Trump’s presidency, markets have become warier, concerned that the Republicans are struggling to implement their policy goals.

In the coming months, we believe markets will focus substantially on the prospects for tax relief legislation. If Congress struggles to pass legislation to raise the debt limit and fund the government, markets could react negatively, surmising that Congressional failure to undertake such basic tasks suggests an inability to deal with the more complex matter of tax reform. This phenomenon was apparent last March, when Republican struggles to pass replacement health care legislation led to the largest one-day drop in the markets since the election. Investors were concerned not so much with the content of the health care bill as they were with whether the failure suggested that Congress will be unable to agree on tax cuts as well.

We believe this extrapolation from the debt ceiling and government funding legislation to tax legislation is misplaced. The former legislation requires Democratic concurrence to pass the Senate. Tax legislation does not, and thus can be passed solely with Republican support.

We continue to believe that Congress is likely to pass tax relief legislation this year. If the Republicans are unable to agree on full-scale tax reform, we believe that Congress will abandon the sweeping goal of simplification to pass streamlined legislation that simply reduces tax rates. It would be too embarrassing for the Republicans, having assumed control of Congress and the White House with the promise of lowering taxes, to fail to pass any tax relief legislation at all this year. There is even a reasonable chance that lower tax rates could apply in part retroactively to the beginning of 2017. (There is a risk that tax cut legislation standing alone will not be revenue neutral and thus could lead to higher deficits down the road, retarding future economic growth. Our guess is that consideration is too long term to affect market approval of business tax relief.)

We suggest that a market retreat this summer in the face of Congressional failure to agree quickly on debt limit and funding legislation could well be a temporary and thus a buying opportunity. We expect Congress will enact some form of tax relief legislation by year-end, satisfying the markets’ craving.


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. They may be reached at www.TheWashingtonUpdate.com.

The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2017. Reprinted by permission. All rights reserved.

The opinions expressed in this article are the author’s own and may not reflect the view of M Holding Securities or WealthPoint, LLC.

File Number:0954-2017

A New Administration in Washington: What Tax Changes are in Store This Year?

For the first time in thirty years, enactment of comprehensive tax reform legislation is a realistic possibility. President Trump has made tax reform a central goal of his new administration, designating simplification and lower tax rates as key drivers of economic growth. In this effort Trump enjoys the vigorous support of the Republican leadership in Congress.

This white paper discusses the proposals for tax reform, the barriers that must be overcome to permit its enactment, and the likely tax changes investors will encounter when all is said and done in 2017.

Why is tax reform so hard?

“Tax reform” typically has two primary goals: simplifying the tax code and reducing tax rates. On their face, these goals are not terribly controversial. Virtually everyone agrees the tax code is far too complex, and most people approve of lower tax rates, at least for middle-income taxpayers.

Yet it is said in Washington, “tax simplification is complicated stuff.” (The quote is from Pamela Olson, former assistant Treasury secretary for tax policy.) The last time Congress reformed the tax code was 1986 under the Reagan administration.

The challenge in tax reform is not so much reaching consensus on the need for simplification as it is assuring that the reform changes do not reduce significantly the revenue the government derives from the tax system. The House leadership in particular is concerned about the burgeoning federal budget deficit and has made clear that reform legislation should strive to be “revenue neutral”.

Standing alone, a reduction in tax rates reduces the revenue generated by the tax system. Thus, most observers agree that reform can be revenue neutral only if the lower rates are joined with a broadened tax base, accomplished by eliminating or curtailing existing deductions and exemptions. All deductions and exemptions – including the most entrenched and most popular – are put on the table for possible change. But each deduction and exemption benefits a particular group or economic sector that does not want to see it taken away. Objections from these affected groups make the passage of comprehensive reform a political challenge.

Achieving Revenue Neutrality

The White House and Republican leadership have focused on two ways to alleviate, at least somewhat, the need to include unpopular revenue raising provisions in the tax reform proposal.

  • Dynamic Scoring. “Scoring” refers to the revenue lost or gained by a piece of legislation, typically as determined by the non-partisan Joint Committee on Taxation (JCT). The JCT typically scores legislation on a “static” basis, that is, without considering many of the longer term economic consequences of the proposal. Republicans assert that the JCT instead should use “dynamic scoring”, which takes into account the enhanced economic growth (and the accompanying additional tax revenue) resulting from lower tax rates.

Trump has set out forcefully the case for dynamic scoring. He posits that allowing individuals and businesses to keep more of their earnings stimulates the economy, as businesses use the retained funds to hire and grow and individuals use the additional wages they receive to purchase more consumer goods. This economic growth in turn raises taxable income and thus tax revenue, recouping at least some of the revenue lost from the reduction in tax rates. Treasury Secretary Mnuchin has even asserted that “the [tax reform] plan will pay for itself with growth.” Washington Post (April 20, 2017).

Although most economists agree that lowering tax rates engenders some economic expansion, there is wide disagreement over how much revenue the expansion generates relative to the revenue lost from lowering tax rates. See University of Chicago Initiative on Global Markets (May 2017) (no economists surveyed believe resulting economic growth will pay for proposed tax cuts). Federal deficits grew in the wake of the major tax cuts enacted under Ronald Reagan and George W. Bush, suggesting that the revenue generated through expansion was insufficient to achieve revenue neutrality. Of course, attributing a growing deficit to a single cause (tax rate reduction) in a complex multi-factor world where spending is not static is an uncertain enterprise.

There is no question that the use of dynamic scoring is a large part of the Republican legislative strategy. Our guess though is that the JCT, even if it uses dynamic scoring, will conclude that economic expansion alone will not make tax reform revenue neutral. Thus, we expect Congress will have to consider curtailing deductions and exemptions to offset at least some of the revenue lost by the reduction in tax rates.

  • Reforming the Affordable Care Act. In addition to tax reform, the Republicans have made reforming or repealing the Affordable Care Act (“Obamacare”) a top priority. The House leadership has stated that passing health care reform legislation first may be a necessary step to completing comprehensive tax reform.

Why does the order in which Congress takes up these apparently unrelated pieces of legislation matter? The answer is that the ACA reform legislation would eliminate the additional taxes imposed by the ACA, such as the 3.8% surtax on investment income earned by affluent families. Repealing those taxes before the tax reform debate lowers the existing revenue baseline that tax reform must match. Conversely, if Congress does not pass ACA reform, then the ACA taxes must be eliminated in the tax reform legislation itself, generating an additional revenue loss that must be recouped through controversial curtailment of more deductions and exemptions. Addressing health care reform first thus reduces the need for some revenue-raising changes and bolsters the feasibility of completing tax reform.

The Tax Reform Proposals

Last July, the House leadership issued a “blueprint” for comprehensive tax reform. More recently, the Trump administration released its own outline. Although there are differences, the two proposals have much in common.

Trump’s plan calls for the following changes to individual taxes:

  • 35% top individual rate (down from the current 39.6% rate).
  • 20% top capital gain and dividend rate (unchanged from the existing rate).
  • Repeal the Obamacare 3.8% surtax (if not already accomplished through ACA reform legislation).
  • Eliminate the alternative minimum tax.
  • Repeal the estate tax and generation skipping tax. An open question is whether the legislation will retain stepped-up basis in assets at death. Under current law, stepped-up basis eliminates a double tax at death by relieving heirs of the obligation to pay capital gains tax on appreciation that accrued during the lifetime of the deceased. Without an estate tax, the need to prevent double tax is eliminated. Repealing both the estate tax and stepped-up basis would essentially substitute an income tax on heirs for an estate tax on the deceased.

During the presidential campaign, Trump, along with eliminating the estate tax, proposed eliminating stepped-up basis for joint estates exceeding $10 million. The new administration proposal and the House blueprint are silent on this issue.

  • Eliminate the deduction for state and local taxes.

For businesses, Trump’s plan calls for:

  • 15% top tax rate on business income. This provision is the heart of Trump’s reform proposal. The current U.S. corporate tax rate of 35% is the highest among developed countries. This high rate has prompted U.S. businesses to move operations (and jobs) overseas. Trump believes that a lower rate will encourage companies to keep their operations in the U.S.

Trump would not limit the business rate reduction to C corporations. His proposal would similarly tax at 15% business income flowing through pass-through entities such as S corporations, partnerships, and LLCs. Currently, flow-through business income is taxed on the owner’s personal return at the highest individual rate. The proposal thus would reduce the tax rate on flow-through business income by almost two-thirds.

Many observers believe a 15% rate will be difficult to achieve on a revenue neutral basis. The House plan calls for a 20% corporate tax rate and a 25% tax rate on business flow-through income.

  • Full expensing of capital expenditures. Instead of deducting the cost of purchasing a capital asset over the asset’s life, the House blueprint would permit businesses to claim a deduction for the full expenditure in the year of purchase.
  • The House blueprint would eliminate the deduction for interest paid by businesses.\
  • Tax the sale of carried interests as ordinary income.
  • Institute a “repatriation holiday”, permitting multinational companies to repatriate offshore earnings at a reduced tax rate. Under current law, income earned by a foreign subsidiary of a domestic company is not taxed in the U.S. as long as the earnings remain offshore. But if the subsidiary repatriates the earnings to the U.S. parent, the U.S. imposes a 35% corporate tax. The U.S. is the only developed country that taxes repatriated earnings.

To avoid this tax, U.S. multinational companies are leaving trillions of dollars in earnings offshore, where they cannot be invested in the U.S. economy. Trump is proposing permitting (or perhaps requiring) offshore subsidiaries to repatriate existing offshore earnings at a reduced tax rate. Although his proposal does not specify a rate, most observers think it would be in the 5-10% range. This “repatriation holiday” accomplishes two goals: providing more funds for investment in the U.S. economy and raising additional tax revenue (because as a practical matter the U.S. will never recoup the nominal 35% tax on offshore earnings).

  • Allow future offshore earnings to be repatriated without tax. Trump’s proposal would eliminate the tax entirely on repatriation of future offshore subsidiary earnings, thereby implementing the “territorial” taxation system adopted by other countries. Thus, foreign subsidiaries could repatriate future earnings to their U.S. parent free of tax.

The House tax reform blueprint also includes a controversial “border adjustment” provision to promote U.S. competitiveness and raise revenue. Under this proposal, U.S. businesses that sell products directly from the U.S. company to an overseas purchaser (that is, without use of an offshore subsidiary) could exclude the resulting sales income entirely from U.S. tax. Conversely, U.S. companies would not be permitted to deduct amounts paid to foreign suppliers. Because U.S. imports greatly exceed exports, the border adjustment proposal raises significant revenue.

Border adjustments would be a boon to U.S. exporters. But the proposal would cause a substantial increase in taxes paid by companies that rely on imports. For instance, many retailers import products manufactured in other countries for sale in the U.S. Under this proposal, a retailer would get no deduction for payments made to purchase products wholesale from a foreign manufacturer, and thus would pay U.S. tax on the full retail sales price. Trump’s proposal is silent on border adjustments; the White House says it is under consideration with possible changes.

In addition to the above, the final tax reform proposal likely will include a series of “loophole closers”, less controversial tax changes to curtail what many members believe are unduly generous tax benefits that may be eliminated in the name of revenue and simplification. Examples of loophole closers could include:

  • Curtail “stretching” of inherited IRAs and 401(k)s.\
  • Apply required minimum distribution rules to Roth IRA accounts beginning at age 70-1/2.
  • Limit Roth IRA conversions to pre-tax dollars.
  • Treat all distributions from S corps and partnerships to owner-employees as subject to employment taxes.

Prognosis for Tax Legislation in 2017

With their sweeping election victory, Republicans can pass tax legislation this year without Democratic support. Normally sixty votes (and thus some Democratic support) are needed in the Senate to overcome a filibuster and pass legislation. However, Congress has adopted a procedure, called “reconciliation”, which if followed permits the Senate to pass most spending and tax legislation with a simple majority. House Speaker Paul Ryan already has said he plans to use this procedure to pass much of Trump’s fiscal agenda, including tax legislation.

Even with only one party involved, however, passing comprehensive tax reform is a prodigious task for the reasons discussed above. Although passage is far from assured, we believe there is a reasonable prospect that Congress will pass tax reform legislation this year.

Investors must keep in mind that tax reform is not an unalloyed benefit for everyone. There will be winners and losers, as changes to deductions and exemptions fall unevenly across economic sectors, businesses, and individual taxpayers. For instance, companies doing business abroad could be helped or hurt, depending on whether they import or export product. Investors must keep a close eye as reform legislation progresses to determine which sectors could lose tax benefits in the name of lower overall rates.

If the Republicans are unable to agree on full-scale tax reform, we believe that Congress will abandon the sweeping goal of simplification to pass streamlined legislation that simply reduces tax rates. It would be too embarrassing for the Republicans, having assumed control of Congress and the White House with the promise of lowering taxes, to pass no tax relief legislation at all this year. This tax rate reduction could be offset somewhat with uncontroversial loophole closers but would be supported largely by an appeal to dynamic scoring. There is even a reasonable chance that lower tax rates could apply in part retroactively to the beginning of 2017. If dynamic scoring overstates the rate of future economic growth, however, tax cut legislation standing alone could further increase future deficits, retarding economic growth farther down the road.


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. They may be reached at www.TheWashingtonUpdate.com.

The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2016. Reprinted by permission. All rights reserved.

The opinions expressed in this article are the author’s own and may not reflect the view of M Holding Securities or WealthPoint, LLC.

File Number: 0782-2017

 

ACA Replacement and Market Reaction

Earlier this month, the Republicans issued their plan to replace the Affordable Care Act (Obamacare). Andy Friedman, “one of the nation’s most sought-after speakers on all things political” according to CNBC, recently discussed the Republican’s plan on the CNBC Nightly Business Report to share his thoughts.

 

 

The Republican plan seeks to replace the ACA subsidies that reduce the cost of insurance purchased on government-run exchanges with refundable tax credits that may be used to defray the cost of insurance purchased in private markets. The credit amount would be based on a recipient’s age and income level. The plan would also effectively repeal the Medicaid expansion beginning in 2020, and would turn Medicaid from a federal entitlement into a state-run program with capped annual federal grants, leaving the states to bear any future cost increases. Furthermore, the plan repeals virtually all of the taxes used to fund the ACA, including the 3.8% surtax on investment income, the 0.9% surtax on earned income and the medical device tax.

While this answers certain questions on what changes the Republicans are proposing to Obamacare, certain questions still remain. The primary questions left to be answered are, 1) how many people who currently have coverage under the ACA will lose that coverage under the Republican plan and 2) how much will the Republican replacement plan cost? The plan eliminates most of the funding sources, such as the 3.8% surtax on investment income. If non-partisan Congressional “scoring” determines the plan would balloon the deficit, it will run into push-back from the deficit hawks in Congress and might concern the equity markets. Similarly, if many families who have coverage under the ACA lose that coverage under the alternative, the plan will run into opposition from moderate Republican Senators who insist that their constituents not be harmed. Lastly, it remains to be determined whether the plan will prompt enough healthy people to purchase insurance to attract insurers willing to issue riskier policies that cover pre-existing conditions on the same terms.


WealthPoint, LLC does not provide any tax or legal advice. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

File #0372-2017

 

Election Day and the Markets

A number of weeks ago – before the release of the Access Hollywood tape that threw Donald Trump’s campaign into turmoil – we predicted that Hillary Clinton would win the presidential election.  At the same time, we predicted that the Democrats would seize control of the Senate, but that the Republicans would keep control of the House.  Events since that time threaten to affect how the markets may perceive these election results.

Control of the House

Some political commentators are now suggesting that Trump’s precipitous fall could cost the Republicans control of the House as well as the Senate.  Democratic control of the House would remove a check on Clinton’s ability to implement her legislative priorities, which include increased spending on social programs and higher taxes on affluent families.

When one party controls the White House and both houses of Congress, the possibility of Congress passing sweeping legislation antithetical to businesses becomes much greater.  During the first two years of his presidency Obama enjoyed a filibuster-proof Congressional majority.  Those years saw the passage of the Affordable Care Act, Dodd-Frank bank reform, and other sweeping legislation viewed by many as harmful to business.

Recent turmoil notwithstanding, we do not believe that the Republicans in fact will lose control of the House in this election.  Thus, we continue to see a Clinton presidency as a continuation of the Washington gridlock of the last six years (since the Republicans assumed control of the House in 2010).  Few initiatives will be enacted and sweeping legislation will be scarce to non-existent.  Instead, Washington will address fiscal deadlines with eleventh hour short term extensions, kicking the can down an abbreviated road.

Although such gridlock is frustrating to many American voters, it might be fine for the markets.  Gridlock virtually eliminates the risk of major legislative changes, freeing the markets to focus less on Washington legislative policy and more on economic developments.  Nonetheless, markets could be volatile through Election Day if portions of the media continue to assert that Democratic control of the House is possible.

A “Rigged Election”

In the third presidential debate, Trump declined to provide assurance that he would accept the election results, saying only “I will tell you at the time.”  Trump’s refusal is consistent with pronouncements he has been making on the campaign trail.  Since the release of the Access Hollywood tape and the subsequent decline in his poll numbers, Trump has asserted with increasing frequently and forcefulness that the election is “rigged” against him.  He posits a conspiracy working to deprive him – through voter fraud and other means — of the presidency he otherwise would have won.  At various times he has singled out as conspirators the media, the Democrats, minorities, the Republican Party “establishment,” international bankers, the FBI, polling monitors, and the debate commission.

Given the tone of his rhetoric, it is hard to imagine Trump making a gracious concession speech and disappearing after the election (assuming he, in fact, does not prevail).  His actions and temperament suggest that the unfairness of losing something he believes he rightfully won will gnaw at and motivate him to continue to seek the comforting support of his followers.  Trump post-election is likely to continue to tweet observations, give interviews to friendly networks (and perhaps start his own), and even schedule the rallies he so enjoys.

The possibility of continued turmoil post-election could cause significant market volatility.  American democracy relies on voters having confidence in election results.  Questioning the legitimacy of a presidential transfer of power come Inauguration Day is unprecedented here.  Yet Trump’s continued exhortations could engender resentment – and even sporadic outbursts of violence – on the part of some of his followers.  Widespread doubt about the integrity of the election results would lead the country into uncharted territory, producing the sort of uncertainty that makes markets nervous.  Thus, market volatility could continue even after Election Day.

Less important in the short term, but nonetheless meaningful for future elections, is the effect on the Republican Party of Trump’s continued crusade.  The intra-party clash between Trump’s supporters and social conservatives is unlikely to disappear after the election.  Conservatives will blame Trump for the election defeat, while Trump will blame the party establishment for abandoning his campaign.  And the traditional free-market, pro-business, fiscal conservative wing will also vie for power.  The ensuing fight could render the Republican Party a shambles, a situation that won’t be resolved quickly.  While the disarray is unlikely to cost Republicans the House in 2018, it could prevent Republicans from taking control of the Senate in 2018 (when the numbers otherwise favor them).


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm.  He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products.  They may be reached at www.TheWashingtonUpdate.com.

The authors of this paper are not providing legal or tax advice as to the matters discussed herein.  The discussion herein is general in nature and is provided for informational purposes only.  There is no guarantee as to its accuracy or completeness.  It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities).  Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2016.  Reprinted by permission.  All rights reserved.

The opinions expressed in this article are the author’s own and may not reflect the view of M Holding Securities or WealthPoint, LLC.

File #: 1712-2016

The Candidates and the Markets: How Would Clinton or Trump Govern?

As the personality-fueled presidential campaign rages on, little time has been spent on how a Clinton or Trump presidency might affect the economy and the markets. Yet the candidates’ respective policy objectives are likely to have profound effects on investors. This paper discusses the fiscal policies a Trump or Clinton administration would likely pursue, whether those policies are likely to be implemented, and how those policies could affect businesses, borrowing, taxes, and the markets.

Our Election Predictions A Review

Here are the predictions from our July white paper, Sizing Up the General Election:

  • The Republicans will keep control of the House of Representatives.
  • The party that wins the White House also will control a majority of the Senate.
  • Neither party will hold the 67 Senate seats needed to override a presidential veto or the 60 seats required to break a filibuster and allow legislation to proceed. The metrics underlying the presidential election (evolving demographics and the Democrats’ natural advantage in the Electoral College), combined with the manner in which the candidates have operated their respective campaigns to date, make Clinton the heavy favorite. But it is too early to declare the race over. Trump’s uncanny ability to control and bend the rules of engagement give him a “puncher’s chance” of prevailing. Facing a heavily favored opponent, he still could pull off an unlikely win by landing a rhetorical punch that gets through Clinton’s defenses and severely rattles her. Until we see how — and whether — Clinton handles the Trump onslaught in their debates, it is premature to declare her the clear winner.

A Clinton Presidency

Hillary Clinton’s fiscal and tax policies hue to the Democratic Party line. She believes that capitalism has hard edges, and government programs are needed to help those in lower socioeconomic classes move up to the shrinking middle class. Clinton advocates for new or expanded government education and jobs initiatives and a higher minimum age. She would not reduce entitlements, instead leaving in place (or increasing) current Social Security and Medicare benefits even for young workers.

Clinton would pay for her initiatives with new taxes that would fall almost exclusively on affluent families. Higher income families, she asserts, have done far better financially in the economic recovery than have working Americans, and can afford to help those left behind.

Based on our predictions, Clinton will face a Republican-controlled House. In our view, Clinton’s unpopularity (over 50% of voters view her unfavorably), coupled with extant Republican antagonism, will significantly compromise the honeymoon period that typically follows a presidential inauguration. We look for a contentious relationship between the House and the White House from the beginning.

House Republicans are exceedingly unlikely to agree to Clinton’s call for higher tax rates and higher domestic spending. Thus, we see a Clinton presidency as a continuation of the Washington gridlock of the last six years (since the Republicans assumed control of the House in 2010). Few initiatives will be enacted and sweeping legislation will be scarce to non-existent. Instead, Washington will address fiscal deadlines with eleventh hour short term extensions, kicking the can down an abbreviated road.

Although such gridlock is frustrating to many American voters, it might not be detrimental to the markets. Markets react negatively to uncertainty. When one party controls the White House and Congress, the possibility of sweeping legislation antithetical to businesses remains a possibility. During the first two years of his presidency Obama enjoyed a filibuster-proof Congressional majority. Those years saw the passage of the Affordable Care Act, Dodd-Frank bank reform, and other sweeping legislation viewed by many as harmful to business. Gridlock virtually eliminates the risk of major legislative changes, freeing the markets to focus less on Washington policy and more on economic developments.

A Trump Presidency

Donald Trump is anything but predictable. That attribute alone has the potential to roil the markets. A number of months ago, Donald Trump, drawing on his bankruptcy experience, ruminated that it might make sense for the U.S. to negotiate a “haircut” on its loan repayments, giving Treasury debt holders less than the face amount to which they are entitled. Trump walked back that comment shortly after making it, but a similarly explosive comment from a sitting president likely would cause significant market turmoil.

Consistent with his “America First” policy, Trump wants to impose hefty tariffs (reportedly as high as 40%) on foreign goods entering the United States. Our trading partners presumably would retaliate with their own tariffs on goods from the United States. Most economists believe the resulting drop in U.S. exports could have a devastating effect on domestic businesses.

In contrast to Trump, most of the House Republican leadership supports broad free trade principles, and thus is unlikely to enact Trump’s radical trade policies. But failure to derail those initiatives quickly could precipitate nervousness in the markets.

On the fiscal side, like Clinton (and unlike the other Republican presidential candidates), Trump would not reduce Social Security or Medicare benefits even for young workers. Also like Clinton, Trump would initiate a large scale infrastructure repair program. And he would spend significantly more to shore up the military. But while Clinton calls for increased taxes on the wealthy, Trump would reduce taxes significantly across the board. Trump’s tax plan is in line with that of the House Republicans, and thus would have a good likelihood of passage.

Although markets initially might cheer lower taxes, the negative consequences to the federal deficit of more spending and reduced taxes could cause overleveraging problems down the road. Thus, a Trump presidency could follow the arc of the George W. Bush presidency, with exploding debt leading to an economic (and market) downturn.

The Fiscal Situation and Taxes

Over the past several years, the deficit has declined steadily from its all-time high in 2009. But, according to the nonpartisan Congressional Budget Office, the deficit is now rising again: the 2015 deficit will grow by a third in 2016. Congressional Budget Office, Long Term Budget Outlook (August 2016). Even in the absence of additional spending, this deficit increase will accelerate in coming years as major entitlement expenditures (Social Security and Medicare payments) grow with the aging population.

Neither presidential candidate seeks to reduce the federal deficit. With spending up, entitlement reform off the table, and the deficit growing, we believe the deficit hawks in the House leadership will be forced to undertake a constant search for revenue. Of course, Republicans will not seek to enact broad tax increases – such as higher tax rates or the elimination of popular deductions or exemptions. Instead, the House leadership is likely to look at less controversial tax changes — smaller items that curtail tax treatment that many in Washington believe is inappropriately generous.

Indeed, this process has already begun. The last government funding compromise (in December 2015) sought partially to recoup increased spending by eliminating a popular (and, in the eyes of many politicians, overly generous) Social Security planning strategy called “file and suspend”.

We believe eliminating the “file and suspend loophole” is a harbinger of things to come. Future funding bills could close other perceived loopholes, resulting in a whittling away of techniques investors use to reduce taxes. Examples of other loophole closures that have been under discussion include:

  • Tax the sale of “carried interests” as ordinary income.
  • Curtail “stretching” of inherited IRAs and 401k’s.
  • Apply required minimum distribution rules to Roth accounts beginning at age 70-1/2.
  • Limit Roth IRA conversions to pre-tax dollars.
  • Treat all distributions from S corps and partnerships to owner-employees as subject to employment taxes.
  • Curtail sophisticated wealth transfer techniques.

Most investors note that taxes already are high. In 2013, tax increases to avoid the “fiscal cliff” and to fund the Affordable Care Act caused the top tax rates on investment income to jump by ten percentage points. As a result, the top 10% of tax returns by income now pay 82% of all federal individual income taxes, the highest number ever recorded. Fairness and Tax Policy, Joint Committee on Taxation (February 2015). Tax rates imposed on upper income taxpayers are now the highest they have been in the past 35 years. The Distribution of Household Income and Federal Taxes (CBO November 2014). And the effort to raise revenue through loophole closers could eliminate many current tax reduction techniques, effectively raising taxes further.

High and increasing taxes make effective tax planning for investments paramount. We review a number of tax planning suggestions – and discuss possible loophole closers in more detail — in our white paper, Investing in a Rising Tax Environment 2016, published earlier this year.

After the election and before the new administration takes office, we will prepare a white paper that discusses in more detail the new president’s policies and their likelihood of enactment, including how the policies could affect individual economic sectors.


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. They may be reached at www.TheWashingtonUpdate.com.

The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2016. Reprinted by permission. All rights reserved.

The opinions expressed in this article are the author’s own and may not reflect the view of M Holding Securities or WealthPoint, LLC.

File #1658-2016

Government funding and tax extenders legislation affects investors

After weeks of negotiations, Congress reached agreement on a bipartisan bill to fund the government through September 2016.  Following are provisions of particular interest to investors.

The legislation makes permanent (including retroactively for 2015) some provisions that previously had expired every few years:

  • IRA / charitable contribution provision for account holders over age 70-1/2
  • Tax credit for research and development expenditures
  • Enhanced write-off of small business capital expenses under section 179

The legislation extends (including retroactively for 2015) other provisions:

  • Extension and phase out of bonus depreciation through 2019

The legislation includes a number of new provisions:

  • Repeals the forty-year-old prohibition on exports of domestically produced crude oil
  • Expands 529 plan qualifying distributions to include student computers and technology

The legislation delays sources of funding and government reimbursements under the Affordable Care Act:

  • “Cadillac tax”(40%)  imposed on high cost employer health plans delayed until 2020; thereafter tax becomes deductible
  • Medical device tax delayed until 2018
  • Annual fee on health insurance provider premiums written (“belly button tax”) delayed until 2018
  • Government reimbursements for insurance company losses limited to amounts collected from profitable insurers (reimbursement fund must be revenue neutral)

Of interest to financial advisors, the legislation:

  • Does not prevent the Department of Labor from finalizing and implementing the proposed IRA account fiduciary rules
  • Does not make significant changes to Dodd-Frank

 


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm.  He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products.  They may be reached at www.TheWashingtonUpdate.com.

The authors of this paper are not providing legal or tax advice as to the matters discussed herein.  The discussion herein is general in nature and is provided for informational purposes only.  There is no guarantee as to its accuracy or completeness.  It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities).  Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2015.  Reprinted by permission.  All rights reserved.

Another government shutdown?

Congress returns from recess next week facing a month-end deadline to fund government operations for the next fiscal year. I’m concerned we could be looking at a reprise of 2013. That year, the federal government shut down on October 1 for sixteen days over a Republican proposal to defund the Affordable Care Act. Now, Republicans are talking about defunding Planned Parenthood, a proposal the President is almost certain to veto. More broadly, there is significant disagreement on funding for social programs generally (the President wants increased funding; the Republicans are calling for social program cuts). If these disagreements cannot be breached, the government faces an October 1 shutdown.

 

The difference this time is when the debt limit must be raised to allow the federal government to borrow additional funds. In 2013, the government ran out of money and had to borrow by mid-October, setting up an incontrovertible deadline that Congress had to address, reopening the government in the process. This year, we’re told that the government will not need to borrow more money before November or even December. So, if the government shuts down, what will force Congress to compromise and reopen it in the near term?

 

Historically, markets often are volatile as fiscal deadlines approach and Congress appears unable to agree on a solution – until it does. Investors might consider taking action to protect against volatility until these deadlines have been addressed. More aggressive investors might view a pullback as a buying opportunity; markets tend to recover nicely after Congress finally agrees to raise the nation’s borrowing limit (as Congress invariably will do here, likely at the last possible moment).

 


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at www.TheWashingtonUpdate.com.

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2015. Reprinted by permission. All rights reserved.

Obamacare upheld again: Consequences for Business Owners and Investors

Presidential Seal

 

 

 

 

Last week the Supreme Court ruled that all qualifying Americans are entitled to receive subsidies to purchase health insurance under the Affordable Care Act, regardless of where in the country they live.  The decision leaves the status quo in place but nonetheless raises considerations for investors and business owners:

  • As interpreted by the Administration, the ACA requires small business owners with more than fifty employees to provide health coverage to their employees beginning in 2016.
  • There remains a concern about inadequate ACA enrollment, particularly by middle- and higher-income Americans.  If enrollment continues to lag, it could lead to significant premium increases, as the insurance pool will not have sufficient “good” risks to balance out the less favorable ones.
  • Speaker Boehner’s legal action against President Obama remains outstanding.  Boehner’s suit objects to the Administration’s unilateral decisions to delay the employer mandate and to reimburse insurance carriers for losses incurred from insuring high-risk people.  A Boehner victory (which most legal experts consider a long shot) could end the carrier subsidies, which likely would prompt carriers to increase premiums or cut coverage to recoup the lost revenue.
  • The decision avoids a decline in health care stock values.  Many companies – particularly for-profit hospitals – benefit from the greater insurance coverage provided by the ACA.  However, premium increases discussed above could cause the feared “death spiral”, in which higher premiums leads to fewer healthy enrollees, which leads to higher premiums, etc.  That consequence could hurt health care stock values down the road.
  • The decision eliminates any realistic possibility of repeal of the 3.8% surtax on investment income for higher-income taxpayers.  Revenue from that tax is used to pay for the bulk of the insurance subsidies that the Court upheld.  There is no realistic prospect of a reduction in tax rates in sight.

 


Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm.  He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products.  He may be reached at www.TheWashingtonUpdate.com.

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein.  The discussion herein is general in nature and is provided for informational purposes only.  There is no guarantee as to its accuracy or completeness.  It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities).  Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2015.  Reprinted by permission.  All rights reserved.

Life Insurance in a Rising Tax Environment

In March, we posted an article about investing in a rising tax environment.  We at WealthPoint thought the article in the link below would be a good follow up to that article.  Please take a moment to read through it.

Rising Tax Environment

Please click the link below.

WP_Marketing Intelligence Report – Life Insurance in a Rising Tax Environment

Wake Me Up When September Ends

Please read this article written by Andrew Friedman of The Washington Update LLC

In my legislative update early this year, I noted that ongoing acrimony between Congressional Republicans and the Obama White House likely precludes agreement on any broad new legislative initiatives this year.  Instead, Congress and the White House are likely to reach agreement only in the face of “forcing events” – deadlines that compel action to ward off a draconian result.

As it turns out, Congress appears to be arranging for all of the major deadlines to occur around a single date – September 30.  This schedule sets up a massive negotiation for September, when Congress returns from summer recess.  Investors should be aware that this negotiation is likely to lead to market volatility and some new tax changes.

I discuss the upcoming imbroglio in more detail below.  But first, two quick announcements:

  • The Affordable Care Act is affecting retiree medical costs in a number of ways, most of them adverse.  A new white paper on the site, Preparing for Rising Medical Costs in Retirement, discusses how retirees and near retirees can develop an estimate of their likely retirement medical costs and a plan to help defray those expenses.  Subscribers can access the paper here.
  • My colleague Jeff Bush recently launched a new way for you to keep with what he and I are reading each day.  You can now follow us on Facebook to see our daily must read articles:  https://lnkd.in/eJAdh88 .  This is our way of keeping you abreast of the latest happenings out of Washington, happenings that can affect your investments and your business.

Now back to the legislative outlook.  By or around September 30, Washington must reach agreement on:

  • Raising the debt ceiling:  Congressional borrowing authority ended on March 15, 2015.  Current estimates suggest the government will run out of money and need to borrow by around early October.  Failure to raise the debt limit by that time would impinge on the government’s ability to pay interest on debt outstanding, leading to default on U.S. debt.
  • Highway funding:  Funding for summer infrastructure work (road and bridge repair) runs out on May 31.  All indications are that Congress will pass a short term “patch”, funding construction through September 30.  After that date, Congress will need to find a permanent source for highway funding.
  • Government funding:  The federal government’s fiscal year ends on September 30.  By that date Congress must appropriate money to run the government next year.  Otherwise the federal government will shut down on October 1.
  • Tax extenders:  Congress wants to extend a popular group of tax provisions that expired at the end of last year.  Paul Ryan, the chairman of the House Ways and Means (tax writing) committee, said he wants to take up the extenders during the funding discussions in September.

Longtime readers will remember that Washington reached a similar September 30 impasse two years ago, causing the government to shut down for sixteen days beginning October 1, 2013.  In that instance, with the debt limit deadline approaching, Congress and the White House agreed on a plan to reopen the government and raise the debt ceiling.  That plan included caps on future spending on defense and domestic programs.

As in 2013, reaching consensus on these knotty budget issues will be challenging.  With U.S. military involvement expanding, both parties agree that next year’s defense budget must be higher than the spending caps set in the wake of the 2013 budget impasse.  The President, though, insists that any increase in defense spending be matched with a corresponding increase in spending on domestic programs.  Republicans not only oppose additional spending on domestic programs, they are looking to further cut those expenditures.

For investors, the September 30 deadline is important for two reasons.  First, as the deadline to raise the debt ceiling gets closer and Congress and the Administration (likely) continue to bicker, the markets often turn volatile.  I have long said that a market decline over concern about Congress’ impending failure to act is a buying opportunity.  Congress will act – likely at the last minute – at which point the market will recover.  It is incumbent on investors and financial advisors to keep these “forcing event” dates in mind as investment opportunities.

Second, meeting these deadlines requires funding for new government initiatives, such as additional defense spending and funding long-term highway construction.  Congress typically does not like to spend money unless it raises taxes (or cuts spending elsewhere) to defray the additional cost.  Congress thus searches for “loophole closers”– provisions in the tax code that arguably provide unduly favorable benefits.  (An example of a loophole closer that keeps arising – but has never been enacted – is to curtail the use of “stretch” IRAs and 401(k)s.)  Thus, as September approaches, investors would be wise to consider how Congress intends to fund additional expenditures.

One way to fund these new initiatives could be corporate tax reform.  As if addressing these deadlines was not enough, Chairman Ryan hopes to have a corporate tax reform plan ready by the end of the summer.  (It appears that reforming individual taxes is now recognized as too difficult politically.)  If Congress and the White House can agree on corporate reform (possible but difficult), then the funds from a deemed (Democrats) or optional (Republicans) one-time repatriation of foreign earnings could be used to fund the permanent highway bill.  Otherwise, Congress will have to find revenue raisers to pay for highway funding and extenders; Ryan says using repatriation funding without tax reform is a no go.

 

Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm.  He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products.  He may be reached at www.TheWashingtonUpdate.com.

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein.  The discussion herein is general in nature and is provided for informational purposes only.  There is no guarantee as to its accuracy or completeness.  It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities).  Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2015.  Reprinted by permission.  All rights reserved.