Investment Insights: Well that was taxing
This weekly report presents insights from our Global Investment Management team.
The tax bill is now in effect, and the myriad of investment managers, accountants, individuals, and corporations are all clamoring to understand the final and future ramifications of the legislation.
The benefits should be felt across the spectrum for tax payers, with some ultimately benefiting more than others. However, the tax bill will likely have some overall positive impact, at least over the short term, as an increase in domestic growth and reduced tax burdens are felt by United States citizens and companies. The longer-term effects are less certain as the bill could increase the projected deficit, ensconce the country in future debt resulting in tough decisions for generations to come and add to the growing issue of inequality, and ultimately may reduce some fiscal measures that may become useful in coming years.
The crux of the bill is the reduction of tax rates for both individuals and corporations to increase spending. The number of tax brackets for individuals was kept at seven; however, some of the bracket rates were reduced with larger reductions toward the middle tax brackets. In the individual tax brackets under previous law, five of the seven brackets have been decreased under the new law when compared to the previous law. Additionally, changes made to increasing standard deductions, a doubling of the estate tax exemption, a cap of $10,000 on state and local tax deductions, and other adjustments to tax law will have substantial impacts on individual earners. The overarching strategy for legislators was to reduce taxes paid such that consumers and corporations will take home more income and then spend these dollars, therefore boosting future economic growth.
It is the contention of both BNP Paribas and the Bank of the West Global Investment team that consumers will spend approximately 80 cents per dollar saved by the tax cuts in the economy, which should result in approximately a 0.2% boost to U.S. growth in 2018. The question arises, with the consumer representing approximately two-thirds of the economy, why doesn’t this juice-up GDP more? One argument is that high-income earners don’t possess the underlying need to increase their spending as much as lower to middle-income earners. Essentially, higher earners are already comfortable in their spending habits such that a tax-cut will not propel them to spend more. Additionally with the doubling of the estate tax exemption, this does skew some of the ultimate benefits for the rich who have potential taxable estates, rather than the middle and lower classes. Regardless, the tax cuts should promote wealth effect tendencies as their after-tax earnings increase or at the minimum stay stable.
The other side of the tax savings is for corporations, which may benefit from two important changes under the new tax law. The corporate tax rate has been reduced from 35% to 21%, which will bring the United States in line with global tax rates for company profits. The other adjustment, repatriation of cash held internationally by U.S companies, is also set to create a potential boost for the economy. There is an estimated 400 billion to 500 billion in cash that could be repatriated back to the United States with a 15% tax rate on liquid assets. This could increase capital project spending, but also bring a fear that corporations would instead utilize the cash for increased share buybacks, dividend increases, or other financial engineering activities. This would ultimately benefit shareholders and the company, but wouldn’t necessarily be a translated boom for business spending and increase job growth creation. Regardless, we believe that this will result in upwards of 0.3% boost to GDP growth.
The resulting summation is that GDP growth in the United States could increase anywhere from 0.3 to 0.5% depending upon the spending multipliers from the tax reform. This means that the Global Investment Management team expects above-average growth for 2018 compared to other years of the recovery. As such, this should help to support equity prices and start to put pressure on the long end of the interest rate curve as investors see strengthening in inflation and growth on the horizon.
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