Global Market Commentary

What the Tax Bill Means For Taxpayers, For Businesses, and For Investors

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The tax bill has passed and has been signed into law, the dust is settling.  Accountants and tax lawyers report that it will be moderately beneficial for most individual income tax payers.  Ambitious reformers had hoped the tax code would be so simplified that most filers could use a post-card, but that wasn’t to be.  Enough complexities remain that there will be plenty of fodder for tax professionals and enough unique situations that we can’t do more than sketch the overall effects for the majority of taxpayers, which we’ll do below.

On the other hand, we believe the bill will be beneficial for businesses — both through its reform of the corporate tax code and through the effects it will have on economic growth and productivity growth.  These direct and indirect benefits or corporate tax reform have already started to benefit workers by encouraging businesses to increase wages.  (Big corporations including AT&T [NYSE:  T], Boeing [NYSE:  BA], Comcast [NASDAQ:  CMCSA], Wells Fargo [NYSE:  WFC], Fifth Third Bancorp [NASDAQ:  FITB], and others have announced plans to return some of the tax-reform savings to workers through bonuses or wage hikes.)

The boost to wages will also be strengthened as the economic effects of the reform come into play.  Workers will benefit further as accelerating economic growth further tightens the labor market and as companies compete for labor.

Investors will also be key beneficiaries — not just from a one-time windfall such as tax repatriation, but from the longer-term effects of productivity growth, coming from capital expenditures encouraged by full expensing.  On balance, it is the corporate tax reform elements that will be the real legacy of the 2017 Tax Cuts and Jobs Act.

The bill leaves a lot to be desired, not least that the partisan atmosphere prevailing on Capitol Hill means that many of its provisions are temporary, including full expensing, which is one of the most significant.  On the whole, though, we think the bill is a victory for American workers, businesses, and investors.

Elements of Corporate Tax Reform

Here are the key components of corporate tax reform included in the bill:

•  It drops the statutory Federal corporate tax rate from 35% to 21%. “Statutory” simply means the headline rate before deductions.  Compared to the average effective rate — what the average company actually pays — the cut will look less dramatic.  Still, the path of lowering rates and reducing loopholes is an excellent one in principle, since a complex system of deductions becomes little more than a playground (or battlefield) for special interests.  Complexity creates distortions by favoring some industries and business structures and penalizing others, as well as creating perverse incentives and expensive, Byzantine tax avoidance strategies.  This move also goes far to putting U.S. companies on an even playing field with their international competitors.

•  It allows full expensing of capital expenditures for five years, and then phases this change out over the following five years (again, the sunset of this provision was driven by the political technicalities surrounding the bill’s passage; the reformers would have liked the change to have been permanent).  This change removes a major anti-investment bias in the tax system, and will encourage a great deal of new capital investment, which will increase productivity.  As we have often observed, productivity growth is one of the key drivers of corporate profit growth — so this change will prove a boon for profits.

•  It creates a new deduction that will bring the top marginal rate of some small businesses and pass-throughs down significantly below the 37% that would have been the highest marginal rate otherwise.  This will benefit small businesses, which as our readers know, are the most significant engines of job creation in the U.S. economy.

•  It abandons in principle the U.S.’ international tax system for a territorial one, again helping to make the U.S. competitive with other jurisdictions (the U.S. had been the only major economy with a worldwide tax system).  A one-time repatriation tax on accumulated profits kept overseas will encourage a lot of money to come back to the U.S. to be spent on productivity-enhancing capital expenditures.

Elements of Individual Tax Reform

Here are some key components of individual tax reform included in the bill:

• It lowers individual rates.  There are still seven brackets, but with lower rates and higher income thresholds.

• It nearly doubles the standard deduction.  One effect of this will be a drop of about 50% in the number of tax filers who need to itemize their deductions.

• It caps the deduction for state and local taxes at $10,000, which will hurt some high-income residents of high-tax states.

• It lowers the maximum mortgage size for mortgage-interest deduction to $750,000 from the current $1 million, and excludes the ability to deduct interest expenses from second homes (though creative structures are likely to find their way around that restriction).

• It doubles the Child Tax Credit.

• It retains many specific deductions that had originally been stricken from the House version of the bill.  Broadly, taxes got lower for many taxpayers, but not much simpler.

On balance, most taxpayers will be directly benefitted (contrary to some of the reporting of the bill that we have seen), albeit not dramatically.  Some wealthy taxpayers in high-tax states will be hurt.  Many working-class taxpayers will benefit both from a direct tax cut, and from wages that will gradually rise because of productivity increases.  Investors will benefit from rising corporate profits driven by productivity growth and GDP growth spurred by increased capital investment.

Investment implications:  Even the direct benefits of the tax bill are likely not priced in.  The indirect benefits will appear gradually over the coming months and years.  The bill makes U.S. businesses more competitive on a global stage, and encourages capital expenditures which will enhance productivity growth, raise wages, and boost corporate profits.  The bill will benefit domestic small and mid-sized companies the most.  In our summary below, we mention some of the industries that we see favorably positioned for 2018’s late-stage bull market, including online retail, logistics, cloud services, engineering and construction and other infrastructure firms, and fintech.  In all of these industries, we would look for companies who are positioned to benefit from tax reform as well as from cyclical rotation.  Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time.  Currently, Guild’s principals and clients own BA.  In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.