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Congress Juggles Tax Bill and Potential Government Shutdown

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NATHAN PETERSON: There’s a lot of news that’s coming out of Washington right now that’s been moving the markets and has big implications for investors: the possibility of a government shutdown and the pending tax legislation. I’m Nathan Peterson, your host for the December 7th Schwab Market Snapshot. And, today, I’m joined by Mike Townsend to discuss these two topics.

Okay, Mike, let’s start with the topic that’s most front and center, that’s the government shutdown. Once again, we’re up against this deadline which is tomorrow, December 8th. Do you think that Congress is going to be able to get a last-minute deal in to keep the lights on, so to speak?

MIKE TOWNSEND: Well, I think they will, but it won’t be easy, and it will only be for two weeks, which means we’re just going to have to do this all again later this month. The House is going to vote on a two-week extension to December 22nd, and while there’s some concern from conservatives about some of the issues, I think that will pass.

Things are a little more complicated in the Senate. The Republicans have a 52-48 majority in that chamber, so that means they will need at least eight Democrats to vote with them in order to get to that 60-vote supermajority that’s filibuster-proof. That means Republicans may have to make some concessions to Democrats on some issues that are important to them, but I do think that they'll get this across the finish line in time.

NATHAN: Great. Okay, let’s say, we do get a government shutdown, how big of a market reaction do you think we’ll get, or, you know, what’s happened in the past when this has occurred?

MIKE: You know, we really don’t think there will be much of a market reaction. Historically, there really hasn’t been. There have been 17 shutdowns since 1976 of at least one day, and the average market reaction has been less than 1% to the negative. And, in fact, the last shutdown, which was 15 days in October of 2013, the market actually reacted 2% positively. So we’re not overly concerned.

NATHAN: That’s good to hear. Okay, so let’s move to the other topic, which I know is on a lot of our clients’ minds, and that is, tax reform. Can you give us an update on where the bill currently stands?

MIKE: Sure. Both the House and Senate have passed their own separate versions of tax legislation. So what happens next is that representatives from the two chambers will come together in a conference to haggle-out all the details, and they have to produce a single consensus bill. Then the House and Senate have to pass that bill in exactly the same form, no amendments, before it can be sent to the president for his signature. So that’s the next key step.

NATHAN: Okay, so, obviously, some differences between the House and the Senate bill. Mike, how big is this discrepancy, and do you think they will be able to come to a consensus?

MIKE: Well, it’s going to be very complicated, because, as you point out, there are some big differences between the bills. You start out with just the fact that the House has four individual tax brackets and a top rate of 39.6%, while the Senate has seven individual tax brackets and a top rate of 38.5%, and you can see that the differences start at really the most basic elements of the proposal. There are really three things that I’m going to be watching carefully as these negotiations continue.

First, what happens to the corporate tax rate. Both bills cut the corporate rate to 20%, but there’s a lot of talk in Washington right now that they may have to come up to 21- or 22% in order to accommodate some other issues.

Second, what happens to the Alternative Minimum Tax, so the AMT. The House repeals the AMT, but the Senate keeps it in place. They do increase the amount of income that’s exempt from the AMT, but this is going to be a very complex issue to reconcile. For Republicans, getting rid of the AMT has been kind of a core philosophical belief for a long time.

The third thing is what happens to the state and local tax deduction. Both bills repeal the state and local tax deduction, and then add back a $10,000 deduction for property tax. But there’s a lot of concern from representatives of high-tax states, like California, New York, and New Jersey, that this has a really negative impact on their constituents. So we’re looking to see whether some additional relief is on the way there.

NATHAN: Okay, sounds like some work to be done. Okay, regarding one of the provisions in the tax bill that’s up for discussion is going to have potentially big implications for investors, and that’s a potential change to how cost basis is calculated. Can you talk about that a little bit for us?

MIKE: Sure. This is definitely something investors need to be paying attention to. The Senate bill would require investors to use the first in/first out, or FIFO method of calculating their basis when they sell shares. Currently, you have the option to choose the lots you want to sell when you sell shares of stock. So this is a big change, and being able to sell which shares you want is a big way to manage your tax liability.

Importantly, this provision is not in the House bill, so this is one of those issues that’s going to have to be reconciled during these negotiations. At Schwab, we think investors should continue to have the choice over how they want to manage their shares. We’re working hard to convey that perspective to lawmakers. We hope that the provision will be dropped from the agreement, but at this point, we just don’t know.

NATHAN: Yeah, definitely something to keep an eye on. Okay, Mike, let’s bottom-line this for investors. Do you think they’re going to be able sign a bill into law before the holidays?

MIKE: Well, I’ll tell you, there is a lot of work to be done, and there are a lot of places where this whole plan could collapse. But, right now, I think the chances are good that a bill will be completed before Christmas.

NATHAN: Great, Mike. Well, thanks so much for joining us today. There’s a lot of valuable information there.

Listen, if you want to read more from Mike, you can do so under the Insights & Ideas section on Schwab.com. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

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