The first entry on this myth opened a few doors about how to hang onto investment gains. This entry looks at challenges that have long plagued investors who want that bird to stay put. Tax cuts and tax reform loom large. The size and shape are not clear but critical factors are beginning to stir up storm clouds.
The Coming Tax Boon
Separate from the good fortune brought on by the surge in stocks and bonds, especially now that the Federal Reserve is allowing interest rates to ascend, tax cuts and tax reform promise massive wealth gains. A likely tax cut will put many millions of cash in the hands of many millions of investors. This will provide a massive stimulus that derives from consumers, not from government policy. With the Fed unloading its stockpile of Treasuries, even skeptics will recognize consumer spending as the homerun hitter in the economic lineup.
In terms of the myth, the giant cash flow may play out in two ways. It will spur spending on consumer goods, which really does not keep the bird in the hand. It will also allow people to move solidly into the middle class. For many Americans, home ownership, earning a college degree, building up one’s savings or retirement package translate into a fixed spot in the venerable middle class. Such achievements keep the bird in the hand and benefit society greatly.
A tax cut can accomplish this more easily than government efforts to push people up the income ladder. The cash influx allows people to make their own choices about the things that matter. Individuals are generally wiser than the government in terms of personal benefit.
Tax reform will come about after a protracted battle. Lowering taxes category-by-category sounds great but slashes government revenue. Many observers including Forbes predict that corporate taxes will shrink by at least 5%. Stockholders do back flips while bureaucrats break out in a sweat. Corporate profits soar, while infrastructure funding and cash to cover the government’s long-term fixed obligations – Social Security, Medicaid, military spending, education, housing, Veterans, social programs, unemployment insurance and SNAP benefits – evaporate. Even the most craven investor should see that the government cannot walk away from its obligations. Government observers also realize that the discretionary parts of the budget are really fixed. Congress believes that a bird in the hand is worth two in the bush. Consequently, they do not want to give up long-standing revenue streams. We are in for a battle.
Reform Schedule A?
Personal taxes are in for a going over also. Suppose Congress cuts deductions for mortgages. Begin by noticing the lack of logic: a tax cut allows more people to own a home, but a cut in the mortgage deduction squeezes the funds families use to pay the mortgage. Evidence shows that the middle class is shrinking as a percent of the population. Making it more difficult to own a home would accelerate that trend.
While entering the middle class seems a reasonable goal and a way of keeping the bird in the hand, the counter argument is that home ownership is strictly for the wealthy. Congress should have learned its lesson when subprime loans led to the last recession. Total mortgage debt in the US exceeds $14 trillion according to the Federal Reserve and will spike following a tax cut. Congress may simply have to protect the wealth of all homeowners and allow people to enter the middle class armed with cash rather than standing on quicksand, such as subprime loans headed for default.
Capital Gains and Estate Taxes
Among the battles taking shape is the issue of new wealth versus old wealth. Tax cuts toss wads of cash at consumers while taxes remove the wads of cash. Tax reform may favor the new home buyer or it may protect the long-time two or three home owner. Old money rests on investments. Capital gains tax reform protects the buy-and-hold, long-term investor. Cutting estate taxes protects wealth gained over a long period and keeps the bird in the hand. Congress finds it easy to dip into these pools of wealthy to fund its needs. Expect a major battle. The Myth Buster sees old wealth making gains as tax reform moves ahead.
Before ending this second entry on “A Bird in the Hand is Worth Two in the Bush,” the Myth Buster would like to re-affirm that the rise in the stock market since last November is no mere blip as some observers are saying. Investors can expect the sharp, upward spurt to slow down while the market moves toward more modest gains. Blips, which exceed the formless bull market, do not last for ten or eleven months. Worriers to the contrary – and they have been quite vocal in recent weeks — the recent stock market pattern concurs with how the market moves: sharp rise followed by slower upward trend.
A long battle is just beginning. Indeed, a bird in the hand is worth more than two in the bush. If only we could figure out how to keep it. In the next piece, we will move to Part III, the final entry, on this all-encompassing myth.
Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.