The stock market rally has been fueled in part by hopes that a big tax cut — of one kind or another — would bump up corporate profits and spending.
But the proposed tax plan with the most punch so far could have a tough time making it through Congress, and that ultimately could mean disappointment for a heady stock market.
It also means the slow wheels of Washington could delay tax reform for longer than the stock market is expecting. "You're going to get a lot of hand-wringing. It's slow, and it's going to be gradual," said Dan Clifton, head of policy research at advisory firm Strategas.
The current House Ways and Means Committee proposal would cut the corporate tax rate from a current 35 percent to 20 percent. That would make a difference for the biggest U.S. corporations, which pay about 25 percent on average.
But the plan is paid for by the controversial border adjustment tax, which is meeting resistance in the Senate. President Donald Trump has not clearly come down one way or the other on the plan, and he meets Wednesday with big retailers who oppose it.
"Whether the Ryan plan passes with the border adjusted tax is highly controversial. ... The Senate is going to be a lot more resistant to it," said Peter Boockvar, chief market analyst at The Lindsey Group. House Speaker Paul Ryan is a big backer of the plan. "I think bottom line is the market is making it seem like there are only winners from tax reform. But with the border adjusted tax, there are going to be winners and losers."
Goldman Sachs economists put the odds of a border adjusted tax at about 20 percent, with opposition growing. Besides concerns about the effect on consumers, the European Union and other trading partners may challenge it with the World Trade Organization.
Trump raised market expectations about tax reform when he promised last Thursday he would debut his own plan in the next several weeks, and it's unclear whether it will be like the House proposal or something else. The concern is the effort could become mired in debate, with the border adjustment tax already seeing industries lining up on both sides of it. The border adjusted tax would put a 20 percent tax on all goods coming into the country and no tax on exports. That pits Boeing, General Electric and Dow Chemical, all exporters, against Wal-Mart, Target and other importers.
"If that tax reform date looks like it's pushed too far in the future, the market reacts negatively to it. We don't think it kills the bull market, but it could pull the market down 3 to 4 percent near term. A trim, not a haircut," said John Stoltzfus, chief investment strategist at Oppenheimer Asset Management.
Trump has previously proposed a plan that would reduce the corporate tax rate to 15 percent. "Our expectation is the forthcoming White House plan will reduce rates largely by expanding the budget deficit, with a small amount of base broadening. By contrast, we expect that the Senate will consider legislation that broadens the tax base somewhat more, but proposes a smaller cut to the corporate tax rate to limit the budgetary effect," the Goldman economists said.
They also said without the border adjustment proposal the tax rate would probably be closer to 25 percent, not much bang for companies already at that rate based on deductions. Small companies, however, would benefit as many of them pay much closer to the 35 percent rate.
The loss of the House border adjustment tax from the plan would be significant since it is expected to raise about $1 trillion over 10 years. It would be a dramatic shift in U.S. corporate tax structure to a destination-based tax, which means that companies would not deduct the costs of imported goods, and would not include export revenue in their tax base.
Rep. Devin Nunes, R-Calif., said Tuesday on CNBC that in his mind, there would be no tax bill without a border adjusted tax. "I don't know any other way to do it. We've long looked at this. We've had exhaustive hearing after hearing after hearing for eight years," said Nunes, a member of the Ways and Means Committee. He said the committee has found the only way to make meaningful changes is to move to a full consumption-based system.
"This is the only way to leapfrog United States tax code in front of every other tax code around the world," said Nunes.
Clifton said House leadership has said this before, and the House does not currently have the 218 votes for tax reform with the border adjustment tax, but Ryan and others believe they have more flexibility to get the tax rate lower with it. He said without Trump's endorsement, it's a hard sell to get other House members on board.
"It's like 'Hunger Games' for tax lobbyists now," said Clifton. "If you're negatively impacted by the border tax, you're pushing the net interest deductibility." Limiting interest deductibility would be a negative for financial firms.
The border adjusted tax is an unknown and for that reason, opponents say it's unclear if it would work quite the way it is expected to. For one, it requires a 25 percent jump in the dollar to prevent the import tax from becoming a tax on consumers and on companies that rely on imported goods. Proponents say it would create American jobs and build up U.S. manufacturing.
"Our own case is you couldn't get the full appreciation of the dollar in one go, and in all likelihood the border adjustment tax would not have the neutral effect that academic theory suggests it might, and would materially benefit net exporters rather than net importers," said Richard Turnill, global chief investment strategist at BlackRock.
The House bill also proposes limiting the deductability of net interest expense and instead allowing companies to fully expense, instead of depreciating capital expenditures. Turnill said that could hurt companies that are highly leveraged, but analysts say that's a feature that could stay in an alternate plan.
Turnill said he believes that the reflation of the global economy has been the main driver of the market, but tax reform is a factor and the process could result in volatile trading as more reform details emerge.
Clifton said a tax plan without border tax adjustment is most likely, and he outlined several scenarios.
One is for a plan that includes 100 percent expensing for a few years instead of having companies depreciate capital expenditures. That could take the corporate tax rate to 23 percent, he said. Tax reform could also include a one-time repatriation of the $2 trillion in corporate cash held overseas, also currently in the House plan. The net interest deduction would also be capped under this plan and existing corporate deductions and credit would be removed.
A second option is a straight tax cut, a proposal that Trump has discussed. But without revenue generation, it could face opposition and potentially result in higher interest rates, as it could add to U.S. debt. Clifton said a straight cut could get done much quicker, and in 2003, a tax cut boosted GDP growth to 7 percent in the third quarter and 5.5 percent in the fourth quarter.
The third fallback plan he sees is a one-time repatriation of overseas cash, together with infrastructure spending. Clifton said the collapsing dam in California is likely to renew calls for major infrastructure plans. He said House conservatives would probably oppose such a plan.
"I do think they will get corporate tax reform.They'll be targeting anywhere from 15 to 20 percent, and I do think repatriation will be a part of it," said Michael Arone, chief investment strategist at State Street Global Advisors. "The big question for markets is going to be the loss of deductions that come along with it. If in fact losing the interest deduction is on the table, that one is important for highly leveraged companies."
Arone said it seems like some border adjustability will be included. "The administration has seemed to warm to it a bit more. After an initial comment that it was too complicated, we haven't heard much more in terms of tweets, comments talking it down. ... The market has already anticipated some form of border adjustability. Folks that import already manufactured goods, that type of thing, earnings could be impaired."
Watch: Seeking bi-partisan agreement on tax reform
