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The Tax Overhaul Cometh

January 2018
By Nanette Abuhoff Jacobson

How might the recent federal tax overhaul spur on the US economy throughout 2018?

 


 

The new $1.5 trillion tax bill is now law. While its long-term impact on the economy is admittedly uncertain, the law achieves more than originally expected. Going far beyond the mere tax cuts that many pundits anticipated, the bill achieves meaningful tax reform. Its passage marks a pivotal moment for the Trump administration and, arguably, the US economy in that it incentivizes capital spending and improves the competitive landscape for corporate America (FIGURE 1).

 

Figure 1
US Statutory Corporate Tax Rates Dropped Dramatically in 2018

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Note: Effective tax rates may vary from statutory rates shown as companies try to reduce their tax burdens.

Source: OECD

 

Three key takeaways

The Tax Cuts and Jobs Act:

1) Lowers the corporate tax rate from 35% to 21%

2) Allows five years of 100% upfront expensing of capital investments

3) Provides a one-time repatriation of foreign-business income at 15.5% and moves the US to a territorial system that allows business revenue/profits to be taxed where it’s earned

Of course, tax reform won’t be the only driver of US markets. An unexpected shift in monetary policy, fundamentals, or valuations could alter the landscape. Still, tax reform is a game changer that will likely boost earnings and support the US economic cycle for at least another 12 months.

Investment Implications:

Domestically oriented or small- and mid-size companies, which tend to pay higher taxes, stand to benefit. These companies generally don’t benefit from foreign subsidiaries or the ability to book income abroad at lower rates.

Retail companies have among the highest effective tax rates (about 31%), as their operations are mostly domestic and, thus, stand to benefit the most from a reduction in taxes

Technology and pharmaceuticals typically have lower relative tax rates. The ability to repatriate foreign earnings at low tax rate should incentivize companies in these industries to increase spending on operations, pursue mergers or acquisitions, or return money to shareholders.

Manufacturers could benefit from the immediate expensing of capital expenditures (capex)

Telecommunications revenue is typically domestic. Wireless companies will likely benefit from an immediate write-off of capex to support the build-out of next-generation 5G networks.

Banks, particularly domestic and smaller banks that currently pay high corporate taxes, stand to benefit as well. I believe investors can expect higher dividend payouts and buybacks. Large-multinational, non-US-based banks with large US operations may underperform their US counterparts, as certain provisions in the new law impose new taxes on them.

Materials and industrials, which are late-cycle industries, are more likely than early-cycle industries to benefit from tax reform. This may be especially true if inflation picks up, which is typical late in an economic cycle.

Managing Director and Multi-Asset Strategist at Wellington Management Company LLP and Global Investment Strategist for Hartford Funds.


All investments are subject to risk, including the possible loss of principal. Small- and mid-cap securities can have greater risk and volatility than large-cap securities.

The views expressed here are those of Nanette Abuhoff Jacobson. They should not be construed as investment advice. They are based on available information and are subject to change without notice. Portfolio positioning is at the discretion of the individual portfolio management teams; individual portfolio management teams and different fund sub-advisers may hold different views and may make different investment decisions for different clients or portfolios. This material and/or its contents are current as of the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.

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