Over the next few weeks, analysis of the Trump administration’s first 100 days will increasingly dominate the news cycle (April 29 is day 100). From a policy perspective, all the action (or lack thereof) will take place over the rest of 2017 and 2018, which is a more realistic time frame for implementing major agenda items. During that time, corporate tax reform will likely take center stage. When it comes to progress on corporate tax reform, financial markets and the economy may respond differently. For markets, a fair amount of upside has likely been priced in, perhaps leaving more downside than upside potential. From an economic perspective, upside and downside may be more evenly balanced. Judging from the elevated levels of divergence between business and consumer confidence and hard economic data, policy uncertainty may continue to delay major spending decisions by individuals and businesses. Further clarity on tax reform may improve the transfer of increased confidence to economic activity. While the U.S. has had a top statutory corporate tax rate of 35% since 1993, the highest current level among developed economies according to the Organization for Economic Cooperation and Development (OECD) data, any company that pays 35% should hire a new team of accountants. The average effective rate in the U.S. is 24%, consistent with other developed economies. For Fortune 500 firms, that number comes down closer to 21%, suggesting tax reform would likely be more beneficial to small and mid-cap companies. Regarding corporate tax reform, two questions will dominate all others. When? And What’s the rate? Expectations for when center on yearend. Passage in 2017 would be considered a success at this point. Passage in 2018, however, would not necessarily be considered a failure if there were clear progress and a solid chance of success. If passage in the new year becomes questionable, both markets and business would likely be disappointed. The president may try to build a coalition that includes centrist democrats by tying a package to infrastructure spending. Unlike the Affordable Care Act, the tax code is a lobbyist’s delight with major reform potentially having district by district implications, creating opportunities for deal making. Tax policy can make odd coalitions because shared interest in defending an industry prominent in a district or state’s constituency can lead to unusual political partnerships, to the frustration of ideological wings of either party. It is unlikely that proposed legislation will simplify the tax code enough to cancel out the inefficiencies (tax accountants, tax lawyers, agencies, regulators) surrounding the current system. It may even create additional costs as the tax machine adjusts to the new rules.
Any benefit would come from the ability of businesses to more effectively and efficiently allocate resources than the government can. Should the reform allow companies to expense capital investments more quickly, the effect may mean more business investment. Business investment would boost productivity, which has been lackluster during the current expansion. Certainly, any business that pays taxes would benefit from lower taxes. The border adjustment tax (BAT), an intriguing idea that turns the corporate income tax into what has been called a destination cash flow tax, may be dead on arrival. BAT is a tax system based on where goods and services are consumed. Therefore, exports, which are consumed abroad, would not be taxed but imports would be. A noteworthy wrinkle is that domestic expenses are counted against profits but overseas expenses are not. Companies that produce domestically for foreign consumption - think complex machines for export still manufactured in the U.S., like airplanes - would be the winners. In theory, the BAT would increase the value of the dollar. Offsetting the disadvantage to importers caused by the tax. If true, the result would eliminate the incentive to relocate abroad, since the tax code would now be indifferent to where a company is based. Although theoretically attractive, the BAT would add complexity to the tax system. Law makers and lobbyists would likely write exceptions to the law to protect constituencies. Rewriting the corporate tax law will be a challenge with lots of political theater. But we guess that it will be easier than overhauling and simplifying individual taxes. We will be watching to see if a consensus builds around reducing the top marginal corporate rate to 25% by the end of 2017. The market has already anticipated the benefits of such a change. Should the perception change, be prepared for more volatility and some disappointment. The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor. • The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. • Data provided by LPL Financial and the Organization for Economic Cooperation and Development. • All investing involves risk including loss of principal