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Why America is going to wake up with a tax cut hangover

Demonstrators against the Republican tax reform bill hold a 'Peoples Filibuster to Stop Tax Cuts for Billionaires' protest rally outside the US Capitol on Capitol Hill in Washington, DC, November 30, 2017.
Saul Loeb | AFP | Getty Images
Demonstrators against the Republican tax reform bill hold a 'Peoples Filibuster to Stop Tax Cuts for Billionaires' protest rally outside the US Capitol on Capitol Hill in Washington, DC, November 30, 2017.

In the fullness of time the recent U.S. tax cuts will prove to have been a major policy mistake and I'll give you several reasons why.

Oh, I know, amidst the stock market party and companies seemingly throwing free $1,000 bonuses around suggesting a coming hangover is like urging moderation to the loudest drunk at the bar. He'll just get pissed off in addition to being pissed and you get nowhere with reason.

But hey, here goes:

Point 1: Tax cuts at this time will prove to be a strategic error. While they may temporarily delay the end of this business cycle, they are nevertheless not changing the outcome. This has one big implication: When the next recession comes tax cuts as a stimulus tool will no longer be an option.

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So congrats, a key stimulus policy tool when needed is no longer a weapon in the arsenal. We just disarmed ourselves. Or in other words, we just gorged ourselves leaving the winter reserves much depleted.

Central banks have been urging governments to implement structural reforms so that the next recession can be better managed and its impact moderated. Tax cuts are not structural reform, they are a short term sugar high benefiting the few despite all the propaganda that is being dished from those that seek to distract.

What? You think that all these companies handing our precisely the same bonus amount ($1,000) is reflective of exactly the same business situation as opposed to a marketing gimmick?

$1,000, as good as it sounds, it's not real long term wage growth, it's like winning a quick pick at the local grocery store. A good giggle, but then it's gone. Doesn't change anyone's long term situation.

No, it's a good propaganda distraction as the real purpose of the tax cuts has never been the economy. That's a false narrative. Which brings us to Point 2.

Point 2: Tax cuts were not designed to stimulate the economy nor wages. I know this statement goes 100 percent counter to the public narrative, but it's nevertheless true and key professionals in the field know it.

Goldman: "'In practice, we expect no significant short-term effect of tax reform on average hourly earnings — as it excludes irregular bonuses — and only a marginal boost to the employment cost index — as irregular bonuses are smoothed out,' said a recent note by Goldman Sachs economist Daan Struyven."

Who benefits? The very people tax cuts were designed to benefit courtesy cash rich lobbyists and their willing recipients in Congress:

"More than three-quarters of the $1.1 trillion in individual tax cuts will go to people who earn more than $200,000 a year in taxable income, who constitute only about 5 percent of all taxpayers, said Karnovitz."

The other consequence and very relevant to my earlier Point 1:

"The tax bill will significantly reduce the tax intake of the federal government in the next 10 years in the scope of 1 percent of GDP on average, Moody's estimates. 'As a result of the legislation, we expect deficits to widen faster than under our pre-passage baseline, resulting in faster accumulation of federal debt, a component of general government debt.'"

In short: The US will be left structurally weaker when the bill comes due and I have alluded to some of this in Macro Alert:

Point 3: Currently Wall Street is giddy about the earnings boost companies will see as a result of tax cuts in 2018. Since all these benefits are non organic, meaning only marginally derived from increased consumer spending, Wall Street has a pretty obvious problem for 2019 and beyond: The earnings growth recorded in 2018 will not be matched in 2019. Earnings growth will compare negatively compared to 2018 in many cases.

Add any slowdown in the economy (think rising interest payments and increased cost of debt carry) and comparisons will fall off a cliff. What's the standard corporate solution when efficiency is needed to make up growth? Take a wild guess and it's not handing out $1,000 bonuses, but rather handing out layoff notices.

Bottom line: Retail currently soaking in the free champagne party will end up getting soaked once the party is over. The top 5 percent will have reaped 75 percent of the tax cut benefit, but the remaining 95 percent will be stuck with the full bill.

"The top 5 percent will have reaped 75 percent of the tax cut benefit, but the remaining 95 percent will be stuck with the full bill."

And when the next recession comes, it will be again up to the Fed to save the day, as Congress will have done nothing on the structural front but have fully pleased their lobbyist overlords. And only in the fullness of time will many people realize the truth: That tax cuts at this time were not implemented with the intent to be the right policy at the right time, but to serve as a robbing of the U.S. Treasury wrapped under the guise of free money for all.

The real world doesn't work like this. And the drunk at the bar will not only have a hangover, but a tab to match. But don't tell him that, or he'll get belligerent.

Sven Henrich is the founder of NorthmanTrader.com, a market site focused on analyzing markets and technical set-ups. He has also been a frequent contributor to CNBC and MarketWatch.

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This article originally appeared on Northman Trader.