Trump’s Proposed Tax Holiday
It was no surprise to learn during the campaign trail that President-elect Donald Trump is no fan of Janet Yellen and the Federal Reserve. Trump made a point of saying that the stock market was overvalued and was being propped up by the Federal Reserve’s artificially low interest rates.
But Trump’s own proposed tax holiday, which would see corporate America bring some of its overseas earnings back to the United States, where it would be subject to U.S. taxes, could inflate stocks to unseen levels.
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“We are in a big fat ugly bubble, and we better be careful,” Trump said during the first presidential debate with Hillary Clinton. Trump has also said that while he has dabbled in picking stocks, he doesn’t have much faith in the markets and said it’s a terrible time to invest because a massive recession is coming. (Source: “In a revealing interview, Trump predicts a ‘massive recession’ but intends to eliminate the national debt in 8 years,” The Washington Post, April 2, 2016.)
First things first: it’s virtually unheard of for someone running for the presidency of the United States to effectively warn Americans to dump stocks and stay on the sidelines, especially when you consider that Trump holds $91.0 million in equities. But more importantly, is Trump right with his assertions?
According to the most reliable metric that measures whether stocks are under or over-valued, Trump is.
The cyclically adjusted P/E (Case Shiller CAPE ) ratio currently stands at 27.17 times average earnings. The 100-year average is around 16. This means stocks are overvalued by 70%. The ratio has only been higher in 1929, 1999, and 2007. Each time it was followed by a crash that exceeded 50%. (Source: “Online Data Robert Shiller,” Yale University, last accessed November 21, 2016.)
But if Trump believes stocks are sorely overvalued and that the U.S. (thanks to the Federal Reserve and Barack Obama) is headed for a recession, why then does he want to implement a tax holiday for corporate America that many believe will simply send stock valuations skyrocketing?
Trump’s Tax Holiday Could Damage Stock Market
On the surface, Trump’s tax holiday sounds like a good idea, repatriating as much as $2.6 trillion in corporate overseas profits where they are subject to less tax. The flood of cash coming into the country due to lower corporate taxes would be used to help kick-start the private sector.
If history is any indicator though, a tax holiday will not have the desired effect. In fact, the last time corporate America took a tax holiday it forgot to tell the U.S. economy. In 2004, Congress, under then-President George W. Bush, enacted a tax holiday for U.S. multinational companies. Taxed at 5.25%, this brought $362.0 billion back into the U.S. economy.
Unfortunately for the U.S. economy, most of that money went to dividends, stock buybacks, and acquisitions. All of that we now know is a form of financial engineering, a clever way for companies to make their bottom lines look better than they really are. This has the added benefit of sending share prices higher.
Between 2004 and 2007 (you have to allow a few years for the corporate America to do the right thing), the S&P 500 increased 32%. The U.S. economy didn’t fare as well. In 2004, U.S. gross domestic product (GDP) was 3.78%, in 2005 it was 3.34%, in 2006 it was 2.26%, and in 2007 it was 1.77%. In 2008, the country slipped into a recession, with a GDP of -0.29%. (Source: “GDP growth (annual %),” The World Bank, last accessed November 21, 2016.)
One would hope that the stock market and GDP would at least be going in the same direction, but it appears that the tax holiday didn’t have the kind of effect Bush was looking for. Not that you can hang the fate of the entire U.S. economy on a tax holiday, but again, it would be nice if there was a blip in hiring and economic growth.
In a report from the staff of the Senate Permanent Subcommittee on Investigations, the 2004 tax holiday cost the U.S. Treasury $3.3 billion in lost revenue over 10 years. Moreover, between 2004 and 2007, the 15 companies that benefited the most from the tax holiday cut more than 20,000 jobs and decreased their research and development spending. (Source: “Repatriating Offshore Funds: 2004 Tax Windfall for Select Multinationals” United States Senate, October 11, 2011.)
Granted, it will take more than a tax holiday to make the U.S. economy run on all cylinders, and the tax holiday doesn’t have any impact on the global economy. But the fact remains, the only thing a tax holiday seems to have had any impact on is the stock market.
Does Wall Street need a tax holiday? It’s not as if corporate America is short on capital. And it’s doubtful that the tax break would motivate Wall Street to make any new investments it wasn’t already making.
This is great if you’re holding stocks, but it isn’t great if it sends valuations into nosebleed territory. It’s especially true if the U.S. economy is, in Trumps words, heading for a massive recession. After all, nothing material has changed economically in the U.S. since Trump was elected. Some Americans may be more optimistic, but that warm sentiment doesn’t drive the U.S. economy.
A second tax holiday was defeated in 2009 but, with Republicans in charge of the house and senate this time around, Trump’s promise of a tax holiday appears to be a lock. Will it be responsible for another run on stocks? And will Trump’s economic policies be able to stave off a massive recession and keep American’s retirement nest-egg safe?
