- Sweeping changes to the tax code should provide a boost for the U.S. economy
- Lower corporate tax rates should increase after-tax profits for most companies
- The new law offers potential upside for investors as well
During the final days of 2017, sweeping new tax legislation was passed by Congress and signed into law by President Trump. The Tax Cuts and Jobs Act contains material changes to the tax code for both individuals and businesses.
In our view, the legislation is likely to influence economic activity via two primary avenues:
- Greater consumer spending as a result of higher after-tax income
- Increased business spending due to a more competitive U.S. corporate tax code and expanded business investment incentives
Based on our evaluation of potential economic and financial market influences, we believe the legislation could offer a measurable near-term boost for the economy and potentially your investments.
The tax bill’s potential economic impact
The federal government’s non-partisan Joint Committee on Taxation (JCT) estimates the new law should leave approximately $136 billion more in the hands of consumers and corporations in the 2018 fiscal year (which ends September 30), and $280 billion more in the 2019 fiscal year. Much of this money will likely be spent, thus stimulating economic activity.
Prior to the legislation’s passage, we forecasted the U.S. economy to expand at a 2.4% rate in 2018 (after subtracting inflation) versus last year’s pace of 2.3%. Given the new, lower tax rates most consumers and corporations will pay (with no anticipated offsetting cuts in government spending), we now estimate the U.S. economy to grow by approximately 3.1% in 2018 and 3.0% in 2019. If achieved, 2018 could see the fastest rate of growth for the U.S. economy since 2007. Some economists suggest that the impact could be even greater due to a technical influence related to international trade.
The potential risk to the economy
We note, however, that stronger economic growth at a time when labor markets are already tight (the unemployment rate at the end of 2017 was just 4.1%) may add incrementally to inflation pressures. A further acceleration of inflation could entice Federal Reserve officials to hike their ultra-short interest rate targets at a faster pace than is otherwise expected, thus offsetting some of the tax law’s economic benefits.
How the new tax laws may benefit investors
It is possible that investors could be big winners under the new code. The corporate tax rate has been cut from 35% to 21% – an adjustment that should boost after-tax profits for most companies. Companies comprising the Standard & Poor’s 500 Index were already expected to see earnings per share (EPS) growth of approximately 10% in 2018, according to consensus estimates published by the financial research firm FactSet. Analysts have been adjusting their earnings estimates higher to reflect the new, lower tax rate, and they could rise even further.
Investors could also benefit from a material increase in corporate share repurchases or higher dividend payments as companies return money held overseas back to the U.S., a process often referred to as “repatriation.”
The legislation implements a one-time tax on all previously untaxed foreign profits. The economic research firm Capital Economics estimates U.S. corporations recently held approximately $2.5 trillion in untaxed foreign capital. After the one-time tax, the U.S. will join most other industrialized nations in only taxing corporations on their domestic profits.
The new foreign profits tax provision could put back into circulation a significant amount of capital that’s been on the sidelines.
Many companies have already announced plans to use this cash to:
- Increase shareholder dividend payouts
- Invest in future growth
- Invest in their domestic operations
- Increase employee pay
- Pay down debt
- Repurchase shares
Near-term growth may come with a long-term cost
The Congressional Budget Office estimates the tax legislation will cost the federal government approximately $1.8 trillion in revenue over the next 10 years. Although stronger economic activity should generate incremental taxes to offset some of this cost, there’s little debate that future government debt levels are likely to be higher.
Federal officials will eventually need to address budget shortfalls via higher taxes or lower spending to avoid serious debt-related consequences.
How you can prepare
Although we believe the tax code changes should favor economic activity and equity markets over the near-term, there are a considerable number of adjustments that could materially alter your tax situation.
Check with your financial advisor to help ensure you are well prepared for potential economic and market influences, and consult with your tax advisor to consider how your tax liability may be affected in 2018 and beyond.