The Verus Team

Weighing the Impact of the Tax Bill

Written by: Derek Majkowski. Any opinions are those of Derek Majkowski and not necessarily those of RJFS or Raymond James.

The big news that came out of Washington, DC at the tail end of last year was the signing into law the 2017 Tax Cuts and Jobs Act.  A plan that simply put, cut individual tax rates, redefined the treatment of individual deductions, and slashed corporate tax rates while also providing businesses with more favorable tax treatment for pass-through income, repatriation of cash and capital, and treatment of expenses.

The enclosed link highlights some of the key features of the new plan.  It was written prior to the final signature from the President, but provides the noted changes.

(LINK) http://www.raymondjames.com/pointofview/done-deal-tax-reform-passes-congress

As has been customary in Washington, the bill was polarizing, confrontational, and an extremely partisan effort that many felt was rushed and filled with flaws.  What is also customary, especially if you find yourself paying attention to, or immersed in the DC scene, is that emotional and dramatic debate quickly ensues.  Often these debates revolve around who wins, who loses, unintended consequences, and what will undoubtedly happen in the future based on this new law.

Regardless of where one falls on the debate, or how one feels about the law, a very real and obvious change has indeed taken place.  The 2017 Tax Cuts and Jobs Act dramatically shifts the management and appropriation of funds away from the Federal Government and into hands of US Corporations and businesses (small and large).

To appropriately put this in perspective, consider for a minute that the US Corporate Tax Rate is coming down to 21% from 35%.  The last time we saw top line corporate tax rates that low was prior to World War II when the top line corporate rate was 19% in 1938-1939. (https://www.irs.gov/pub/irs-soi/02corate.pdf)

Stepping away for a moment from the partisan debate on outcomes and trying to handicap the broad impact of this plan, let’s consider the economics of this new reality.  Specifically how these extra funds could further impact a company’s balance sheet, and by extension, the potential value of stock prices (if publicly traded). 

In addition, consider that our role as advisors is to look past emotional debate, and try to provide objective guidance and opinion based on a number of variables.  One of which is weighing (among other things) present day fiscal, monetary, and tax policy, and how they could influence portfolio valuations and potential market direction.

With regard to this new tax policy, generally speaking, I do not believe anyone can yet understand what the actual dollar impact will be based on the significant drop in the corporate tax rate.  Assume however, that these additional net earnings to companies are spent on stock buybacks, paying dividends, making acquisitions, reinvesting in the company, updating equipment, or passing profits through to employees and perhaps the community via a range of endeavors.  Is there potential impact there – and if so, to what extent?  Can it realistically be measured at this point?

Understanding it is extremely difficult to pinpoint how stock price is influenced by implementing one or several of these initiatives.  It would seem to me generally though, most of these actions are pro-business, and makes investing in companies and potentially owning equities (stocks) more attractive.

To what amount, and for how long?  Again – as we have always said – it depends and who knows? 

There are multiple reasons to own, or not own stocks.  Each person’s, or company’s investment policy is determined by one’s respective timeline, resources, and risk tolerance.  Within a well-crafted investment plan, equities have to make sense, and if they do fit, well there seems to be some compelling reasons currently to have equities (stocks) in one’s portfolio. 

For others, you may not be in a position to own, or are content and do not want or need to own stocks.  After the run-up in stock prices in 2017, perhaps many would prefer to be less in stocks.  That’s fair and may be completely appropriate for someone’s overall asset allocation strategy. 

Point being - these are all individual and plan specific questions and directives that should be discussed with an advisor. 

With regard to the high-level discussion around what this tax plan means for companies, markets, and investors.  It is hard to overlook the prospects of entering a period where the very innovative companies of 2018 are about to operate in a low tax rate environment not seen in 80 years.  It’s very difficult to know specifically how that will translate to stock prices, economic activity, and overall prosperity, but...

Add to that an environment where interest rates remain historically low, central banks around the globe remain generally accommodative, and we have not seen much – to date - in the form of inflation.  This says nothing about the heavy push for deregulation that is taking place here in the US (another partisan topic).  

Overall, these conditions seem to set-up well for stocks.  Does that mean it will translate to higher stock prices?  Well no – of course not. 

As a leading indicator, it has long been presumed that stock markets price in potential market influences ahead of time, and the current prices may already reflect the benefits of a more favorable corporate tax environment.  Also, we have no idea what the impact of stimulating business activity with such a large cut in corporate taxes and repatriation will have on potentially over heating the economy, in-turn pushing up inflation and potentially forcing interest rates to move higher.  Not to mention any other risks that could derail momentum – geopolitical as an example.

Bottom line is that measuring the impact of the tax plan and how it will translate to market prices is impossible to pinpoint with both the timing and the numbers.  There are also uncontrollable variables that are also difficult to handicap.  That all said however, the lowest corporate tax rates in 80 years, and a dramatic shift away from a Government and Central Bank led economy to a business led economy certainly makes the set-up for stock prices moving forward look interesting.

To what extent beyond where we are now?  We’ll see.  It is certain to come with passionate and continued debate.  In the meantime, broad stock markets began 2018 hitting new all-time highs.

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This information has been obtained from sources deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Investing in stocks always involves risk, including the possibility of losing one’s entire investment. Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues. These matters should be discussed with the appropriate professional. 2018-001174