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The Implications for Tax Reform from the Death of Obamacare Reform

Date Posted: July 20, 2017

Republicans Give Little Confidence for Enacting Major Legislation

The failure of the senate to pass legislation to reform Obamacare may lead to important implications for future success of tax reform efforts. Clearly, the Republican Party shows little ability to unite behind most important legislation. In a past commentary, I referred to a quote made by a twentieth century humorist Will Rogers. His quote: “I am not a member of any organized political party, I am a Democrat.” That quote now applies strictly to the divided Republicans. In comparison, the Democrats in both houses of Congress showed a united front. Will Rogers would be proud.

The Seeds of Tax Reform Concerns from the Defeat of Obamacare Reform

The Republicans made a key change to Obamacare reform legislation, which, in my opinion, brings into question their ability to unite behind tax reform proposals. The proposed healthcare bill eliminated the 3.8% tax on investment income for high earners. Democrats criticized the healthcare bill as taking away from the poor and giving tax cuts to the rich. Republicans crumbled under that criticism and returned the Obamacare tax on investment income to the bill.

The Democratic Strategy to Defeat Tax Reform – Will the White House React

A similar Democratic approach will likely be used again against tax reform proposals. We would expect Democrats to again pound against tax reform that lowers earned income tax rates for high earners. Their pitch will be that the rich will receive most of the tax cuts under the republican tax reform proposals. In addition, the same criticism will likely be used against tax reductions for capital gains and dividends. Some Washington observers even suggest the White House may consider not lowering tax rates for high earners to counteract this criticism. This suggests that personal tax reform will be even more modest than the already reduced expectations from a dithering Congress.

How Congress will deal with corporate tax reductions and changing the taxation on corporate income earned outside the United States remains uncertain. However, we eventually expect more bi-partisan support for moving from a global to a territorial taxation approach for U.S. domiciled corporations. The big supporters of this change come from the technology industry that tends to be close to the Democratic Party

Investment Conclusions

From an investment view, if marginal tax rates for higher income individuals remain in place, then municipal bonds will retain their attraction or even increase. After the first release of tax reform proposals to reduce earned income tax rates, municipal bond prices came under pressure. The reason, lower personal tax rates would reduce the attractiveness of muni bonds. With the delay and uncertainty for tax reform, muni bond prices recovered. More important, the stimulative impact of unconventional monetary policies used since the great recession have pretty much run their course. Economists looked to fiscal policy to pick up this slack — tax reform and infrastructure spending. What we see in Washington reflects their inability to provide the fiscal policy tools necessary to accelerate economic growth. Certainly, what we see in Congress should disturb investors’ longterm confidence in fiscal policy solutions. Bottom-line, investors should not base their decisions on assuming new fiscal policy tax or infrastructure legislation. I will close citing comments from Jamie Dimon, CEO of J.P. Morgan, speaking on the bank’s earnings call: “economic growth would be stronger if Washington had been able to break the gridlock and make intelligent decisions.”