Global Head of Fixed Income and Public Policy Research Michael Zezas and Head of Global Evaluation, Accounting and Tax Todd Castagno discuss the market and economic implications of proposed tax extensions and tax cuts.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income Research and Public Policy Strategy.

Todd Castagno: And I'm Todd Castagno, Head of Global Evaluation, Accounting and Tax.

Michael Zezas: Today, we'll focus on taxes under the new Trump administration.

It's Monday, February 10th, at 10am in New York.

Recently, at the annual meeting of the World Economic Forum in Davos, President Trump stated his administration will pass the largest tax cut in American history, including substantial tax cuts for workers and families. He was short on the details, but tax policies were a significant focus of his election campaign.

Todd, can you give us a better sense of the tax cuts that Trump's been vocal about so far?

Todd Castagno: Well, there's tax cuts and tax extensions. So, I think that's an important place to set the baseline. The Tax Cuts and Jobs Act (TCJA), under his first administration, starts to expire in 2025. And so, what we view is, the most likelihood is, an extension of those policies going forward. However, there's some new ideas, some new contours as well. So, for instance, a lower corporate rate that gets you in the 15 per cent ballpark can be through domestic tax credits, new incentives.

I think there's other items on the individual side of the code that could be explored as well. But we also have to kind of step back and creating new policy is very challenging. So again, that baseline is an extension of kind of the tax world we live in today.

So, Michael, looking at the broader macro picture and from conversations with our economist, how would these tax cuts impact GDP and macro in general?

Michael Zezas: Well, if you're talking about extension of current policy, which is most of our expectation about what happens with taxes at the end of the year, the way our economists have been looking at this is to say that there's no net new impulse for households or companies to behave differently.

That might be true on a sector-by-sector basis, but in the aggregate for the economy, there's no reason to look at this policy and think that it is going to provide a definitive uplift to the growth forecast that they have for 2026. Now, there may be some other provisions that could add in there that are incremental that we'd have to consider.

But still, they would probably take time to play out or their measurable impact would be very hard to define. Things like raising the cap on the state and local tax deduction, that tends to impact higher income households who already aren't constrained from a spending perspective. And things like a domestic manufacturing tax credit for companies, that could take several years to play out before it actually manifests into spending.

Todd Castagno: And you’re kind of seeing that with the prior administration's tax law, the Inflation Reduction Act. A lot of this takes years in order to actually play through the economy. So that's something that investors should consider.

Michael Zezas: Yeah, these things certainly take time; and you know back in 2018 it had been a long ambition, particularly of Republican lawmakers, to reduce the corporate tax rate. They succeeded in doing that, getting it down to 21 per cent in Trump's first term. Now, Trump's talked about getting corporate tax rates lower again here. If he's able to do that, how do you think he would do that? And would that affect how you're thinking about investment and hiring?

Todd Castagno: So, there's the corporate rate itself, and it's at 21 per cent currently. There is a view to change that rate, lower it. However, there's other ways you can reduce that effective tax burden through what we've just discussed. So enhanced corporate deductions, timing differences, companies can benefit from a tax system that ultimately gets them a lower effective rate, even if the corporate rate doesn't move much.

Michael Zezas: And so, what sorts of companies and what sorts of sectors of the market would benefit the most from that type of reduction in the corporate tax burden?

Todd Castagno: So, if you think they're mosaic of all these items, it's going to accrue to domestic companies. That might sound kind of obvious, but if you look at our economy, we have large multinationals and we have domestic companies and we have small businesses. The policies that are being articulated, I think, mostly orient towards domestic companies, industrials, for instance, R&D incentives, again powering our AI plants, energy, et cetera.

Michael Zezas: Got it. And is there any read through on if a company does better under this policy – if they're big relative to being small?

Todd Castagno: There are a lot of small business elements as well. So, I mentioned that timing difference, being able to deduct a piece of machinery day one versus over seven years. So, there's a lot of benefits that are not in the rate itself that can accrue through smaller businesses.

Michael Zezas: YAnd what about for individual taxpayers, particularly the middle class? What particular tax cuts are on the table there?

Todd Castagno: So, first and foremost is the child tax care credit. So, it’s current policy, but after COVID, it was enhanced. A higher dollar amount, different mechanism for receiving funds. And so, there is bipartisan support and President Trump as well, bringing back a version of an enhanced credit. Now, the policy is a little bit tricky, but I would say there's very good odds that that comes back. You know, you mentioned the state and local tax deduction, right? The politics are also tricky, but there could be a rate of change where that reverts back to pre-TCJA.

But one of the things, Michael, is all these policies are very expensive. So, I'm just curious, in your mind, how do we balance the price tag versus the outcome?

Michael Zezas: Well, I think the main constraint here to consider is that Republicans have a very slim majority in the House of Representatives and the Senate, and they're unlikely to get Democratic representatives crossing the aisle to vote with them on a tax package this large. So, they'll really need complete consensus on whatever tax items they extend and the deficit impact that it causes this is the type of thing that ultimately will constrain the package to be smaller than perhaps some of the president's stated ambitions.

So, for example, items like making the interest payments on auto loans tax deductible, we think there might not be sufficient support for that and the budget costs that it would create. So ultimately, we think you get back to a package that's mostly about extending current cuts, adding in a couple more items like that domestic manufacturing tax credit, which is also very closely tied to Republicans larger trade ambition. And you might also see Republicans do some things to reduce the price tag, like, for example, only extend the tax cuts for a few years, as opposed to five or 10 years.

Todd Castagno: Right.

Michael Zezas: Todd, thanks for taking the time to talk.

Todd Castagno: Great speaking with you, Mike.

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