Bomb cyclone? When I heard that news headline, I thought surely that was the latest tweet emanating from the White House. Or maybe a comment on the president’s hairdo. But, no, it’s a relatively obscure meteorological term for the intense wind, rain and snow storm that hit the Cape and eastern seaboard a bit more than a week ago.
Still, it would have been an apt description for the rushed new federal income tax revamp that became law just before the calendar flipped to the new year. Despite the law’s alleged attempt at “simplification,” accountants are calling it the “Accountant Job Security Act.”
To be fair, the structure of the bill will allow many more taxpayers to avoid itemizing deductions, and file simpler tax returns. And it will reduce taxes for a lot of taxpayers, arguably as many as 60 percent to 80 percent of households, although many of the tax cuts for those taxpayers expire in 2025, unless extended.
But many other taxpayers and tax preparers are left guessing at what the consequences will be. The bill was signed into law so close to the end of last year that there was no time to deliberately sort through the provisions, and run tax scenarios, especially given the comparative alternative minimum tax calculations that needed to be done. In short, there was too little time to contemplate the intended consequences, and, maybe more importantly, the unintended.
Some of the intended consequences were clear. The $10,000 cap on combined deductions for property taxes and state and local taxes made the law a direct assault on states with high income tax and property tax rates, like California, New York, New Jersey and Massachusetts — which also happen to be largely Democratic voting states. Overall, taxpayers in states with low or no tax on income, like Florida, New Hampshire, Texas and Nevada, save money under the new law. Those also happen to be generally Republican voting states.
Blatant political assaults like that often come back to haunt the perpetrators. Just ask the Democrats, who changed some Senate voting rules to simple majority votes from 60 percent majority votes when they controlled the Senate.
Given the new tax disincentives, it’s easy to imagine more snowbird voters, particularly from liberal Democratic Northeast states, taking up permanent residence (six months and a day) in states like Florida, and tipping the voting scales in those states in favor of the Democrats — certainly not an intended consequence of the Republican tax bill.
Many of those high-tax states will also face daunting fiscal challenges as a result, like Connecticut already does.
While it’s hard to separate the ordinary ebbs and flows of supply and demand and other unrelated cross-currents in the markets, there’s early anecdotal evidence that property values, rental occupancy rates and rents are falling in New York City. In the face of lost state and local tax deductions and new caps on mortgage interest, one New York penthouse occupant lamented she’d rather sell, and buy a penthouse in Florida. Hardly a third world problem, but nevertheless possibly a foreboding omen for New York City tax revenues. And perhaps an irony for Donald Trump’s family, who have extensive New York real estate holdings.
Perhaps unanticipated in the year-end frenzy were the taxpayers who rushed to increase their deductions and charitable giving for 2017 to benefit from current tax law. That will probably reduce federal tax collections for 2017, compounding the likely fall in collections for 2018.
A clear positive in the new law is the reduction in the corporate income tax rate from 35 percent to 21 percent, which will make the U.S. more competitive with other countries, and perhaps stanch the exit of U.S. companies to friendlier tax climes. Other provisions will help repatriate some of the cash hoards U.S. companies have been keeping abroad to avoid U.S. taxation. The law also imposes a more rational and less onerous rate structure on corporate profits earned overseas.
Importantly, the new law lowers income tax rates for many individual taxpayers and small business owners. Health care costs, however, will likely turn out to be another matter.
The combination of all of those features will free up funds for business investment, higher wages, consumer spending and shareholder returns in the form of dividends and stock buybacks — all of which should serve as positive boosts to the economy.
An unintended consequence, however, is that reduced tax collections could substantially add to budget deficits and the federal debt. The bet is that increased economic activity will lead to significantly higher tax revenues over time, which will offset the short-term declines in tax collections — a much less than certain outcome.
While not aimed at charitable giving (except for a tax surcharge on a handful of large college and university endowments), an unintended consequence of the increase in the standard deduction is a fear that it will reduce donations from smaller givers who will no longer itemize deductions. Effectively without a tax break on their donations, those donors might be less inclined to give. We’ll know more about that dynamic in April 2019.
Some corporate earnings will take a paper hit, because their tax-loss carryovers are now worth less at lower tax rates. Some of those deferred tax benefits, a remnant from the economic crisis, were sizable, particularly among banks. In most cases that should be a short-term phenomenon that will turn into a positive in the longer term. Meanwhile, it could cause enough investor disquiet to roil markets.
Then there are interest rates. If tax breaks spur sharply increased economic growth, which, in turn sparks inflation, the Federal Reserve may raise interest rates more quickly than it currently intends. Any resulting economic slowdown may negate a good part of the tax rate reduction elixir. Rising rates also mean the government will pay more to service its debt. On the positive side, many long-suffering fixed income investors will benefit.
There are a lot of moving parts to the new tax law. And there will be lots of consequences, some intended, and some not. We won’t know how those balance for some time.
Meanwhile, the markets are enthused by the prospects for mostly positive outcomes, sending stocks higher.
Let’s hope there aren’t some nasty surprises in store along the way.
— Barry Paster owns Bridge Creek Capital Management LLC, a fee-only equity and fixed income portfolio manager. His column also appears on www.capecodtimes.com. He may be reached at PO Box 648, West Barnstable, MA 02668; by phone at 508-362-9566; and by e-mail at email@example.com.