I just got back from a trip to Mexico and South America. Talking to the people in Belize, Cozumel, and Roatan remind me (and my children) how lucky we are to live in the United States. We have such abundance here yet we complain so much. Americans have even less to complain about with the new tax cuts. Let’s face it, many people do not like President Trump for various reasons. But let’s not confuse our emotions with the fact that most Americans will have a lower tax bill in 2018 and beyond. Small business owners which drive most employment will will get a tax reduction which will encourage hiring. The new tax bill will also encourages large multi-national companies to bring back money to American shores.
I know some of our clients will disagree with our position, but our economic analysis indicates a bolster in the growth rate in the economy long term. It will probably take a couple of years to see it’s benefit. President Trump will probably push his contacts in the business world to act sooner rather than later, so there is a chance that the benefits to hiring could happens sooner.
The New Tax Bill – Fiscal Policy Review
Both individual taxpayers and companies will see broad changes for deductions and tax rates. The emphasis of the tax bill, known formally as the Tax Cuts & Jobs Act, is to stimulate economic activity via new and higher paying jobs. This is why many of the changes directly benefit large and small businesses in order to encourage hiring.
Some of the tax provisions enacted by the new tax act will be temporary, while others permanent. The cost of reduced tax revenue brought about by tax cuts may only be viable for a certain period, thus producing more immediate benefits from tax cuts rather than later.
Affecting essentially every taxpayer is the increase in the standard deduction, which is meant to simplify the tax preparation process by replacing itemized deductions with a larger standard deduction.
The IRS estimates that about 95% of the businesses in the United States are pass-through entities, such as sole proprietors, S-Corps, LLCs, and partnerships. These entities are called pass-throughs because the profits generated are passed directly through the business to the owners, which are taxed at the owners’ individual income tax rates. The new tax law allows for a 20% deduction of that income, thus reducing overall taxable income. According to the Tax Foundation, pass-through businesses account for over 55% of all private sector employment, representing over 65.5 million workers nationwide. (Sources: IRS, www.congress.gov/bill/115th-congress/house-bill/1)
Short Term Rates Heading Higher – Bond Market Overview
I have been talking with clients over the past few months advising them to alter the fixed income part of their portfolios. If we continue to see strong growth, bonds will probably continue to perform poorly. Having a strategy of short term corporate and municipal bonds blended with a long term bonds and guaranteed rates makes the most sense. We have also been recommending short term high yield bond instruments as well with very long dates bonds as a hedge against a zero interest rate scenario. This leads us the the Fed’s recent actions.
The Federal Reserve raised a key short-term rate as expected by the markets and made fairly optimistic comments about economic growth projections for 2018. The federal funds rate rose to a target range of 1.25 – 1.50%. The increase is a strategy of tightening and also meant to alleviate inflationary pressures. Concurrently, the Fed is also shrinking its $4.4 trillion balance sheet, a dual monetary policy effect expected to curtail inflation and reduce stimulus. Members of the Federal Reserve indirectly expressed concern about the labor market, suggesting that improvements in the job market were expected to ease. The Fed committee also maintained a conservative growth estimate for 2018 of 1.8%, hinting that the new tax plan may not yet produce economic benefits in 2018. The yield curve flattened throughout 2017, with a rise in short term rates and a drop in longer-term rates. The yield on the 2-year Treasury Note had its largest annual increase in over 10 years, ending the year at 1.89%, up from 1.22% at the beginning of January 2017. The benchmark 10-year Treasury bond yield saw almost no change in 2017, falling to 2.40% at year end from 2.45% in the beginning of January. The current Chair of the Fed, Janet Yellen, is scheduled to chair her last Fed meeting on January 30th & 31st, with Jerome Powell assuming the post in February. (Sources: Federal Reserve, U.S. Treasury, Bloomberg)