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Taxes, Politics and Mr. Bannon

David R. Kotok
Wed Jul 19, 2017

"Since the Great Recession, which is now 8 years old, we've been growing at 1.5 to 2 percent in spite of stupidity and political gridlock, because the American business sector is powerful and strong. What I'm saying is it would be much stronger growth had we made intelligent decisions and were there not gridlock.... It's almost an embarrassment being an American citizen traveling around the world and listening to the stupid s--- we have to deal with in this country." – Jamie Dimon, CEO, JPMorgan Chase (Hat tip Politico)

Behind the scenes at the White House, we are told that Steve Bannon has been arguing for higher taxes on the wealthy and advising President Trump to advance them, in a move more politically strategic and symbolic than substantive in percentage terms. Several other sources have confirmed that such discussions are underway. See Josh Green’s article at Bloomberg for more:

So, why is this strategy gaining a hearing and what does it mean?

The early Trump line and Republican euphoria after the election was encapsulated in the tax-cut proposal released by House Ways and Means Committee Chairman, Kevin Brady. We wrote about that proposal at the time: The timeline was this year and a possible attachment to a continuing budget resolution. So much for timelines and political gridlock now raises questions about next year.

All that euphoria has faded into history; and many observers, including us, now see little chance of any tax cuts this year. There still seems to be a consensus or majority view to repeal the alternative minimum tax (AMT). And a repeal of the carried-interest provision has a lot of support. Many would also like to see a large repatriation incentive tied to the funding of a national infrastructure program.

Those elements seem to be heavily supported by both political parties and by the majority of independents who think about policy issues and are inclined to swing in elections.

So maybe the Bannon argument can gain traction?  Is that what will move things beyond the gridlock?

Simply put, Democrats cannot blame Republicans for giving breaks to the rich if the top rate goes up. A 40% number is higher than a 30-something number. Also, the healthcare legislative debacle seems to assure that the 3.8% Obamacare tax will remain. And the changes in taxation have already inserted an income threshold (means testing) for Social Security recipients.

The new bottom line for income taxation is a 40-something top federal rate with high-taxation states like New Jersey and California adding enough to drive the top combined marginal rate above 50%. At Cumberland we have such clients and routinely see combined net marginal rates in the low 50s.

This vision also implies that capital gains rates will end up about where they are now, with no breaks coming this year. In high-tax states with restrictive tax codes, the marginal long-term cap gain rate can reach the 30s.

For markets, under the circumstances, those waiting for a lower-cap-gain setting will require a lot of patience unless they decide to forgo thumb twiddling and adjust nimbly to the new reality of no likely tax reform. This outlook makes tax-free munis more desirable since muni investors focus wisely on their net, after-tax investment returns.

And for the majority of Americans who work and earn, this outlook offers no relief, with the present complex tax code eating up the results of labor effort by tagging FICA (Social Security plus Medicare), Obamacare, and state and local taxation onto their federal calculations. For many working Americans, the federal income tax chews through fewer dollars than these other taxes do, taken together.

Meanwhile, our dysfunctional and discredited two-party political system fiddles in Washington in the spirit of an Emperor Nero in a burning Rome. And maybe I should suggest that the new fiddle is a balalaika.

The country wants reparation of a trillion dollars and a rebuilding of our decrepit infrastructure. The politician who understands these national priorities will find resonance in the forthcoming midterm elections. Those who ignore those priorities do so at their peril.

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