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Ed Yardeni: What the New Tax Law Will, and Won’t, Do for the Economy

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Don’t look for the Trump tax revamp to trigger runaway exuberance in the stock market. After all, passage of the new law has been mostly discounted, argues Ed Yardeni, president and chief investment strategist of Yardeni Research, in an interview with ThinkAdvisor.

The independent strategist discusses the impact of the new tax law on individuals (who get temporary cuts set to expire in eight years) and corporations (which get permanent cuts), and the risk these decreases pose to the U.S. economy a bit down the road.

Yardeni, whose consulting clients include institutional portfolio managers, corporate treasurers and government policymakers, examines implications of the tax cuts to high earners and just how long investors have to wait to know specifics on how the cuts will benefit corporate earnings.

Yardeni founded his consultancy in 2007 after 25 years on Wall Street as chief economist at EF Hutton, Prudential Securities and C.J. Lawrence, as well as chief investment strategist of Deutsche Bank Securities. Earlier, Yardeni, who received a Ph.D. from Yale, had short stints at the Federal Reserve and the U.S. Treasury.

ThinkAdvisor spoke with the strategist on Dec. 14, on the phone from his office in Brookville, Long Island, New York. He explained precisely why he blogged, in November: “The administration has to raise taxes to cut taxes.” Here are highlights of our conversation:

Are there any big losers because of the tax package?

High earners in high-tax states will wind up paying more because state and local deductions are going to be severely reduced. The question is: Will that translate into political pressure on these states to reduce taxes? I suspect there could be. The tax program could lead to more people leaving places like New York, Connecticut, New Jersey and California and moving to states where taxes are much lower, like Florida and Texas.

How will the new tax law affect the stock market?

It should be very positive for the market. But investors will have to wait at least until first-quarter earnings conference calls — which won’t happen till April — to get feedback from management on just how the cuts will affect after-tax earnings.

Do you think the market has already discounted the tax cuts?

Yes, to a large extent. I’m not convinced that the passage of this program is going to lead to much more euphoria in the market because it already pretty well discounted that we [were] going to pass the package.

How will the tax cuts affect the U.S. economy?

It won’t hurt the economy. If anything, the risk is that it might overheat it. But that’s not immediate. In the past, we’ve usually had tax cuts when the economy was weak and we were trying to revive economic activity. This program was sold as a way to boost the economy and create more jobs. But we’re basically at full employment now. So the economy is already quite hot.

What will be the immediate impact, then?

It will probably help the economy, and we’ll see corporations repatriate money. Some of that may be used to hire people and expand capacity, and some to pay dividends and [for stock buybacks].

Is this program really tax reform?

A tax reform would imply that the tax code is going to be several thousand pages shorter than it is now. I don’t see that that’s the case. I wouldn’t characterize it as significant tax reform. But it’s a tax cut for a lot of people who aren’t making a lot of money, and it’s a tax increase for the few people that are making quite a bit. Given that it’s a Republican plan, it’s actually remarkably progressive.

The tax program has been criticized as chiefly a strategy to benefit corporations. What do you think?

The Democrats have pounced on the cut in corporate taxes, which I’m not sure is all that meaningful given that corporations have used deductions to reduce their tax rate anyway.

Please explain.

The data suggests that on average, most companies are already paying 20% or less versus the proposed cut and statutory rates. [With the revamp] the rates drop to 21%, and a lot of the deductions that corporations have been taking would no longer be available. But those deductions are the ones that were very handy in helping them lower their rates from 35% statutory closer to 20% or even less.

Some expected President Trump’s economic program to be Reaganesque. Do you consider it so?

Reagan’s policy was to lower taxes for individuals across the board; it wasn’t aimed at corporations.

How much did Reagan’s cuts help the stock market?

The market has fond recollections of how well both the economy and the stock market did under Reagan. But the reality is that a lot of what Reagan did bore fruit under [Bill] Clinton’s presidency.

How will the Trump tax plan affect the middle class?

It depends how you define “middle class.” There are plenty of families making $150,000 to $200,000 that some people would consider to be very well off and others would consider to be very middle class and struggling to [manage] their [upscale needs]. Middle-class people may have a slightly lower tax rate and maybe a less painful experience filling out their tax forms because all they have to do is put in the standard deduction vs. itemized deductions.

You blogged that “the administration has to raise taxes to cut taxes.” Please elaborate.

The tax program focuses exclusively on tax cuts and not on any cutbacks in outlays. If you’re going to cut taxes, at the same time you have some constraints on what those tax cuts might mean to the deficit. So you need to come up with some offsetting tax increases. I think that’s why there was the move to reduce the deductibility of mortgage interest expense and state and local taxes.

What advice do you have for financial advisors to help clients understand the tax revamp?

Advisors who have done a good job advising their clients to be in this market for the past several years should tell them that the bull market isn’t done yet and to stay with it.

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