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Trump economy plan: From plow horse to race horse through tax cuts

By David Guttery

President-elect Trump wants a race horse economy, not a continuation of the plow horse we’ve had for the past several years.      

Out of all of his proposals, the one that should help the economy the most is corporate tax reform, in particular a big cut in the tax rate on profits to 15 percent or 20 percent from 35 percent at present.  Typically, corporate profits are subject to two layers of tax: first, when the company earns the money; and secondly, when that same money flows to shareholders in the form of dividends or capital gains. 

David Guttery

David Guttery

So, for example, a dollar of pre-tax profits is reduced to 65 cents at the corporate level and then 49.5 cents if the profits are distributed to high-earning taxpayers.  (The 65 cents are taxed at a 23.8% rate, including the Obamacare-surcharge.)

In effect, these earnings face an effective tax rate of just over 50% (not even considering state income taxes), likely on the wrong side of the Laffer Curve.

In addition, cutting the top tax rate on regular income should help spur economic growth, as many entrepreneurs and partnerships face very high tax rates as well.  Lower tax rates will support a game changing build out of domestic energy infrastructure.  

But tax policy isn’t the only point of fiscal focus.  Investors need to watch government spending as well.  Cutting taxes without getting control of government spending is not a recipe for long-term economic growth.  Instead, reducing spending will help entrench expectations that lower tax rates would remain in place.

Every dollar the government spends ultimately has to be paid for by taxpayers, either through taxes today or debt, which simply obligates future taxpayers to make payments to bondholders.  Either way, there’s no free lunch.     

Spending hit a 30+ year low in 2000 at 17.6 percent of GDP.  Now federal spending is at 20.9 percent.  I see the heavier load of government as the overweight jockey weighing down the private sector, preventing it from moving faster.     

In the next year or so, be looking for entitlement reforms that reduce long-term spending commitments in Obamacare and Medicaid as well as reductions in non-defense “discretionary” spending.          

Back in the 1980s, President Reagan not only cut taxes but cut spending relative to GDP as well.  President Clinton also cut spending.  By contrast, spending went up during the presidencies of both Bushes and under President Obama as well. 

So far, President-elect Trump has talked a good game on taxes but has been sending mixed signals on spending.  Investors need to pay attention to both.  

What might a “plow horse to race horse” economy mean to investors in 2017?   On monetary policy, I wouldn’t be surprised if three or four rate hikes were on the table.  A March rate hike is possible, but I think the Fed will wait until after tax cuts become law before it pulls the trigger. 

The 10-year Treasury yield could be near 3.25 percent by the end of 2017. 

I believe we have the potential for a strong bull market in 2017.  The Capitalized Profits Model suggests the fair value for the S&P 500 Index is 2,757 assuming a 10 year treasury yield of 3.5 percent.

Now that oil prices have rebounded, the energy sector should be a tailwind for economy-wide profits, not a headwind.  Nothing is guaranteed obviously, but given the potential for pro-growth strategies from the Trump Administration, this is how the year may unfold.

David has been in practice for 26 years, with a distinctive focus on the management of retirement assets for the production of durable income.  David R. Guttery, RFC, RFS, CAM, is an Investment Advisory Representative of Ameritas Investment Corp, and President of Keystone Financial Group, in Trussville, Alabama.  David independently offers securities and investment advisory services through Ameritas Investment Corp. (AIC) member FINRA/SIPC. AIC and Keystone Financial Group are not affiliated.  Additional products and services may be available through David R. Guttery or Keystone Financial Group that are not offered through AIC.  

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