After passing both chambers of congress earlier in the week, today President Trump signed the most sweeping tax reform bill since 1986. This $1.5 trillion tax cut was a win for corporations and individuals alike, and a needed victory for the White House in the administrations first year. As the bill was debated and voted on, Congress once again showed its ugly head of partisanship as the Senate voted 51-48 and the House of Representatives voted 224-201, along party lines.
We see the most significant parts of the tax reform bill to be the following:
- The corporate tax rate was slashed from 35% to 21%. For years, economists across the political spectrum have argued that the U.S. tax code was globally uncompetitive and created a disincentive for corporations to invest. At 35%, the U.S. was the highest taxed economy among the 35 members of the Organization for Economic Cooperation and Development (OECD) – basically, the wealthiest free nations. With the rate falling to 21%, the U.S. is now in the middle of the pack and will be much more competitive in the global market. Additionally, the tax reform bill provides an inexpensive way for corporations to repatriate cash that has been parked offshore. Early responses from corporations are positive: a) AT&T immediately announced a $1,000 bonus to each of its 200,000 employees and a $1 Billion commitment to capital investment in the U.S. during 2018, and b) Wells Fargo and Fifth Third Banks increased their minimum wages to $15/hour. Clearly, corporate America feels an immediate sense of tax relief.
- Individual tax payers should experience reduced taxes primarily due to: a) reduced tax brackets, and b) an increase in the standard deduction to $12,000 for individuals and $24,000 for married couples filing joint returns. Though the deduction for state and local taxes was capped at $10,000 and the personal exemptions eliminated, the net result should be more money in the pockets of Americans. According to the Wall Street Journal, 48% of households will receive a tax cut greater than $500 in 2019.
- Home ownership across the country may be somewhat curbed as interest is no longer deductible on mortgage amounts over $750,000.
The risks associated with this tax bill relate to the increased debt ultimately layered on the country. Federal Reserve Chairman Janet Yellen noted that this makes a bad debt situation worse. According to the OECD analysis, the national debt (currently at 77% of Gross Domestic Product-GDP) should grow to 100% of GDP by 2027, versus 91% before the tax reform. However, if economic growth is stronger than expected due to tax reform, the gap narrows.
We view this development as positive for both the economy and for the equity markets. While it is undetermined how much the bill will add to economic growth, at a minimum it should further push out any risk of recession that, over the near term, would threaten one of the longest economic recoveries in history. While the bill should create a positive economic impact, the key question for investors is: “how much expectation has been built into the market and will we experience a material correction before the market takes its next leg up?” As always, we will attempt to take a prudent approach to risk going forward, and will likely take advantage of any market weakness to position for longer term opportunities.
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