The tax code we have lived under for the past decade was written as the Tax Cuts and Jobs Act of 2017, which created the existing tax brackets, expanded the standard deduction, provided exemptions to the Alternative Minimum Tax and generous gift and estate tax exemption amounts, a $10,000 limit on state and local tax itemized deductions and created the Section 199A deduction for up to 20% of qualified business income for passthrough business owners.
All of this is set to expire on January 1 of next year. As a result, the Congressional Republicans are working overtime to extend and potentially make permanent the basic tax structure that was created when the Republicans last enjoyed majorities in both the House and the Senate. The goal is to finalize a bill by Memorial Day.
The framework for tax extension is a bit messy this time around, since the TCJA tax provisions, along with Covid, blew up the federal deficit. We can find some of the outlines of how Con1 gress is going to go about rescuing its 10-year-old creation in the budget proposals which passed along party lines in both houses. The House version instructs the Ways & Means Committee—which handles tax legislation—to submit a bill that raises the federal budget deficit by no more than $4.5 trillion (!) over the next ten years— meaning it can write in $4.5 trillion in tax cuts that wouldn’t have to be offset by government spending reductions.
This, interestingly, is slightly below the $4.6 trillion estimated cost of extending the current tax provisions over the next ten years. That overage can (and probably will) be offset by cuts to the federal Medicare program, which provides low-cost health insurance to low-income households.
However, other provisions in the Republican-led platform that would be added to the new legislation could push the overage back up over the limit. That includes eliminating taxes on tips and doubling the state and local tax deducTAX BILL IS COMING tion to $20,000. These might be offset by eliminating credits for electric vehicles and home energy efficiency improvements, and by raising the top individual tax bracket to 39.6%.
The Senate budget proposal kind of cheats; it estimates that extending the current tax regime for the next ten years would add nothing to the budget deficit. So its limit is $1.5 trillion of additional cuts—creating an estimated $6.1 trillion shortfall over the next ten years. Thus, the Senate version of a tax-cut-extension bill doesn’t require a lot of painful spending reductions.
At some point, the two houses will have to compare notes and come to an agreement on a final bill. But it appears certain that the sunset of the 2017 tax bill, which loomed so large in tax planning circles, will be pushed back for another 10 years.
Calm Before The Storm?
Investors appeared to be CALM BEFORE THE STORM? importers to rush to get prodencouraged by an inflation report which showed an increase in core inflation of just 2.3% in March, down from February’s reading of 2.7%. Maybe the massive new tariff regime won’t raises prices after all.
Unfortunately, the rosy inflation report, and a report showing that consumers went on a buying frenzy at the end of last year, will almost certainly be what some will call a ‘deep fake.’ Ironically, the threat of tariffs has induced 2 cuts into the country before the prices were hiked at the border, and consumers were buying early for basically the same reason. Overall personal consumption expenditures rose 1.8% in the first quarter, but this was down from the 4% rate in the fourth quarter. It will drop further if prices go up.
The darker clouds on the horizon include the fact that first quarter American gross domestic product (GDP) suffered a small decline, and hiring was down in April. Meanwhile, the trade deficit reached a record $162 billion in March. There have been reports that the U.S. economy’s already in a recession (these things are only known once the data has been collected after the fact), but it’s impossible to predict whether this will be a shallow trough (with minimal market damage) or something more serious.
The Markets’ Message
Long-term market watchers no doubt find it fascinating how the investment markets are engaging in a surprisingly frank dialogue with the White House over the tariffs. Whenever the news involves a hardening stance on tariffs, the markets drop. Whenever there is a pullback or pause, the markets rally.
The unpredictable element in all this is when, where and how the Trump Administration, and President Trump himself, bows to the pressure of the markets—or not, and the plan seems to change weekly if not daily.
The reason for this ‘conversation’ is that the announced level of taxes placed on goods and services coming into the United States are unprecedented in modern times, more severe even than the infamous Smoot Hawley assessments which were one of the triggers of the Great Depression. Then, as now, the purported logic behind the tariffs has something to do with protecting American industries—except that now, many of those industries have been built on an international system of free trade. ‘Protecting’ them by raising their costs means that there will be short-term hits to profits (if they swallow some of the additional costs going into the Treasury) or sales (if they pass on those additional costs in the form of higher prices). Neither option raises the value of a company’s stock or longterm prospects.
But… Won’t the tariffs eventually bring manufacturing jobs back to the U.S.? At present, in part due to automation, just over 8% of Americans work in manufacturing, and economists have calculated that closing the borders altogether to foreign trade might increase that by one or two percentage points at most. There would be no surge in employment for the middle class.
But… Won’t the high tariffs bring other countries to the U.S. on bended knee, to beg for relief? Basic psychology suggests that when somebody attacks you, and then invites you to negotiate, you’re less, rather than more, likely to respond cooperatively. The more likely result, which has been seen around the world, is reciprocal tariffs designed to punish the United States economy and force the White House to negotiate. The question to ponder is whether the United States can win an economic trade war with the entire rest of the world while, at the same time, here at home, the markets are sending their own messages
Sources:
https://www.kitces.com/blog/tax-cuts-and-jobs-act-tcja-sunset-budget-resolution-reconciliation-salt-cap-qbi-deduction-congress-republication-house-senate-bill/
https://apnews.com/article/stocks-markets-autos-tariffs-trump-earnings-bbad7ca16bceb8c35822d906b195f5d2
https://www.investors.com/news/economy/gdp-pce-inflation-federal-reserve-adp-sp-500/
https://www.hks.harvard.edu/faculty-research/policy-topics/public-finance/explainer-how-do-tariffs-work-and-how-will-they