What is the most important tax issue in this election?

Stocks traded higher yesterday with the Dow and S&P landing on new high peaks as investors bask in the setting sun of the Fed’s oversized rate cut. The waiting game begins for what might be the next big catalyst for stocks and bonds; some may be just around the corner.

Brass tax. If there is a third rail within THE third rail, it would have to be a discussion around taxes. We all know that we have a duty to pay taxes to ensure our safety and prosperity as a nation. Nonetheless, nobody, I mean nobody, likes paying taxes. That makes it easy for a politician to offer nonbinding tax breaks to voters they wish to woo. You want the vote of the Professional Cat Groomers Association of America (it’s a real thing, trust me), you can promise no taxation on cat grooming income. I mean, how bad can that be for the economy? It can’t be that much lost revenue, and perhaps it can win back some votes lost on that “cat mothers” comment. All joking aside, tax cuts… promised tax cuts are one of the oldest strategies in the book, right behind kissing babies.

President George H.W. Bush (the Dad) infamously proclaimed “read my lips: no new taxes.” The proclamation made at the 1988 Republican National Convention drew huge applause. I would bet that even the leftiest Democrats watching the convention on TV secretly applauded. No one likes paying taxes… as aforementioned. Unfortunately for President Bush, things didn’t work out too well on that promise. The Federal deficit was ballooning, the economy was swooning, and the budget had to be balanced, causing Bush to relent in 1990. Many believe that his not making good on the promise cost him the election in 1992. Remember, the Government… YOUR Government’s main source of income is taxation. If it collects less, it has less to spend… unless it borrows more. Side note: the US National Debt is around $35 Trillion, more than twice as much as it was just a decade ago. It was around $22 trillion before the pandemic… you know what happened after that 😳. In order to understand the relative magnitude of national debt, economists like to look at the debt to GDP ratio. Obviously, the US would have more debt than a country with a smaller GDP. Using that measure, the US has a debt/GDP measure of around 123x. That is not great in the grand scheme of things, but it is far better than say Japan, Singapore, Greece, and Italy with ratios of 254x, 162x, 158x, and 139x respectively. For some perspective on the other side, Germany has a ratio of just 63x! Germans don’t like debt.

There are two ways to improve that number. Either increase GDP or lower debt. Increasing GDP… well, we’re on it, but you know that is like an up and down thing. However lowering debt requires either taxing more or spending less. Remember, this is all about less taxes. Oh, did I mention that in addition to not liking taxes, most people don’t want to give up on the services provided by the Government. It’s a tricky business and near impossible to manage effectively in practice. Regardless, politicians have made promises of lower taxes fair game in elections. How we pay for those is usually in the fine print and would likely require some OTHER voting block to foot the bill.

In the current Presidential elections, taxes are not surprisingly a top-of-the-deck issue. No one likes to pay taxes 😉. Both candidates, neck and neck, statistically, have now resorted to what I would call tactical tax cuts. You want to win lower middle-class voters? Promise them a tax cut. Who will pay for it? The evil corporations and high-income earners, of course. You want to curry favors from workers in the rust belt? Eliminate taxes on overtime. How about hospitality workers in blue states? No taxes on tips, of course. Who will pay for that? Well, let’s not get too deep on this. Right now, both candidates have made lots of promises, all of which will come at some cost to the national debt. It is very confusing, and it will get more confusing yet as we draw closer to the big day. So how do we filter all that and decide what is important… what is real?

Well, being that this is an investment-focused note, let’s start there. Higher national debt will lead to higher borrowing costs and higher yields on bonds, period. We all know what higher interest rates / borrowing rates can do to the economy. Don’t worry, it won’t happen overnight, but it will probably affect your children and grandchildren. Now we got that out of the way. In the near term, the one tax program that can affect your wealth most still remains the “Tax Cuts and Jobs Act (TCJA)” of 2017. That is due to expire at the end of 2025. If it does, you will likely pay more income tax and even more pertinent to this note’s focus, so will corporations. That means corporate income will be squelched. That is NOT good, by any measure, for your stock portfolio. Beyond the extra costs to companies, it makes US corporations less competitive on the world stage. While the next President will certainly have a hand in either renewing it, modifying it, or letting it lapse, NOTHING will happen without Congressional support. It is the job of Congress to wage taxes. It is also Congress that approved the budget and the debt ceiling. Sure, the President can apply political pressure to lawmakers, but it is lawmakers that make the… um, make laws… er, do the tax thing… which nobody likes. So, if you really care about taxes, pay attention to the Senate race, which is also too tight to call at the moment. Oh, and to complicate things, the next President still has to sign off on whatever lawmakers come up with. So, if you earn your wages in tips, rely on overtime, have lots of young kids, are middle class, live in a high local tax region, earn more than $400k a year, or rely on social security, I would not go out and start spending more money on hopes of a miracle. If you own a cat, don’t expect your groomer to cut you a break either. Do cats even need grooming? 🐈🙀

YESTERDAY’S MARKETS

NEXT UP

• FHFA House Price Index (July) is expected to have risen by +0.2% after slipping by -0.1% in June.
• Conference Board Consumer Confidence (September) may have risen to 104.0 from 103.3. This is important. Remember confident consumers consume, which is good for an economy, especially if it is slowing.
• Fed Governor Michelle Bowman will speak today. She is a known hawk and THE SOLE DISSENTER IN THE LAST RATE CUT.
  
  

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