What to look out for in US tax reform process

Donald Trump has promised much and delivered little in his time at the White House, with roadblocks coming from congress and the courts. However, that is about to end, as the likeliness of a raft of US tax reforms appears to be on the rise as we head into year-end. Crucially this is also the big ticket item that markets wanted the most, with growing expectations driving the Dow Jones, S&P 500, and Nasdaq into new highs throughout the year.

Whether or not we take on 2018 with this same bullish outlook is going to be heavily reliant on the ability to pass these reforms, rather than whether the Federal Reserve (Fed) will raise rates or not in December. The process has so far thrown up some hurdles which must be overcome to get the tax cuts across the line. There are two main issues which must be overcome, should the current House and Senate packages move into the negotiation phase.

Time of corporate tax cut

The Senate plan differs from the House proposals on a number of fronts. However, one of the key things that stood out for markets was the decision to push the corporate tax element of the reforms into 2019. A major delay to arguably the most important part of the bill (to markets at least) would lessen the near-term positive impact to US stocks, yet would provide a longer term and less dramatic impact.

That being said, to some extent this could help prolong the bull market at a steadier pace, rather than one short-term blowout. As we move towards the negotiation phase, where the House and Senate will have to find a compromise between the two bills, it is likely that the timing differences could be resolved rather than providing a roadblock.

Individual mandate

The Senate version of the bill also sought to extend the reach of the tax reforms, by simultaneously attempting to kill off Obamacare via something called the ‘individual mandate’. The individual mandate is a requirement that everyone in the US needs an insurance policy of a minimum standard, or else face a penalty. The removal of the individual mandate would likely undermine the ability to maintain the core Obamacare tenet that insurance firms cannot exclude or penalize people for their prior or current illnesses.

With the Democrats unlikely to support such a move, it will be down to the Republicans to garner enough internal support for this move to pass it. Given the controversial nature of this attempt to stop the notion of universal coverage, this could be a key roadblock both in the Senate, and then ultimately within the Congress negotiation phase.

Recent weeks have shown the process to be surprisingly quick, with Republicans hoping to expedite the process to enable it to be on Trump’s desk by his Christmas deadline. This speed has seen many economic and political experts raise their expectations of whether (and when) these reforms will occur. Alec Phillips, a Goldman Sachs political economist has raised the likeliness of an early 2018 reform introduction from 65% to 80%. Meanwhile, Marko Kolanovic, JPMorgan Global Head of Derivative and Quantitative Strategies, has said that markets were being overly pessimistic about the chances of a reform package being implemented.

It is this potential mispricing of the tax reforms which are of particular note, with the possibility of substantial upside for indices should it come to fruition. Looking at the Dow Jones Industrial Average (DJIA) chart below, there is a clear hurdle to overcome at 23,526, where a breakout could spark another strong move higher for the index. Keep an eye out for signs of progression in the tax reform process, with particular attention paid to the corporate rate timing. With a clear uptrend in play for US stocks, we could yet see substantial upside if these reforms are passed in the coming months.