With global equity markets enjoying the biggest weekly inflow since the election on what BofA described was rising expectations of a Trump tax deal, the obvious question is “what is the probability of the Trump tax deal getting done.” And, as it turns out, that is also the wrong question, because as Morgan Stanley shows, the outcome from Trump’s tax proposal is not binary. In fact, there are nine distinct possible results, depending on how the various binomial outcomes pan out.
But first, here is a snapshot of how Morgan Stanley’s Michael Zezas sees the infamous one-pager (which was fully explained by Goldman Sachs earlier in the week).
A starting point, but we don’t think the timing of tax reform is advanced: The release is a signal that the White House is taking more of a leadership role on tax than they did on healthcare. Yet that fact alone doesn’t change the barriers to action and likelihood of delays (1H18 is our estimated timing), in our view, for the following reasons:
- Republicans still pursuing elusive healthcare deal – Until Republicans ‘cut bait’ on repealing & replacing Obamacare, they can’t practically start the detailed work of advancing tax reform through the budget reconciliation process. While we see little practical reason for Republicans to remain focused on healthcare, the recently proposed MacArthur amendment signals renewed dedication to the effort. As such, our concern is that they become bogged down in passing amendments to AHCA that satisfy the concerns of moderates, conservatives, and Senate reconciliation rules.
- A credible bipartisan path remains unclear – The tax plan offers several talking points that garner bipartisan agreement, but the policy details make that agreement more difficult than it appears. We don’t see evidence of a credible, bipartisan ‘workaround’ to reconciliation in this document. For example, personal tax breaks appear to favor the middle class by some measures (doubling the standard deduction), but the wealthy & high income earners by others (potential absolute dollar benefit of rate cuts, estate tax elimination). This leaves the plan open to criticism from the Democratic base, who have set a bar for what constitutes acceptable tax reform. Infrastructure & childcare plans have been suggested as bipartisan carrots, but were not detailed in this proposal.
- White House leadership doesn’t necessarily speed the process – While executive leadership earlier in the healthcare process might have been the right move, it’s not necessarily the case here given greater party unity around most tax reform concepts. Hence, leadership is just as likely to muddle and delay the process by creating larger ‘principles’ debates.
It is worth noting, that among the 9 or so distinct scenarios when lumped by probability outcomes, Morgan Stanley believes that there is a nearly 50% chance, 43% to be exact, that the result of Trump’s tax proposal will be a drag on the economy, with just a one in three chance that whatever Trump does will be a true stimulus (the other options are “mixed”).
Morgan Stanley’s takeaway:
We expect delayed and/or disappointing fiscal outcomes, but seemingly right-sized investor expectations may make this point academic in the near term. We concede that the release affirms that a timely tax-cut-driven fiscal stimulus is in play. But we’re not inclined to increase our current 33% odds of stimulus, either by reducing odds of failure to act in a timely manner or by limiting the odds of outcomes featuring pay-fors that alleviate potential deficits and carry near-term downside risks to the economy.
This point may be academic, though, in the near term, if investors have right-sized their expectations, permitting other factors to drive markets. Our US equity and Treasury strategy teams have noted that this is largely the case, and at our recent DC Macro Conference investors had muted expectations for a fiscal boost (58% did not believe a fiscal stimulus would come in the next 12 months; 68% believed a tax reform would not be delivered before the end of 2017). In the meantime, we of course will continue to watch for signs that fiscal optimism becomes a bigger market driver, hence elevating risks of fiscal & tax disappointment.
Finally, here is Morgan Stanley’s full Probability Decision Tree for tax reform:
Collapsing the various outcomes into “stimulus”, “drag” and “mixed” yields the following table: