The Market Implications of US Tax Reform a Bit Unclear

Efforts to overhaul the US tax code have been a long time in coming (more than three decades), but this year it finally came to fruition. Congressional approval of sweeping tax reform will impact individuals, businesses—and the entire economy. Ed Perks, chief investment officer, Franklin Templeton Multi-Asset Solutions, offers his perspective of the likely economic and market implications.

Broadly speaking, the market appears to have been pricing in the passage of the tax reform bill, thus we don’t expect a major reaction as President Trump signs it into law. Some market observers have expressed optimism that US tax reform will prove bullish for stocks—and the economy overall—but the reality is that there will be some winners and losers and we don’t ultimately know what the magnitude of the impact will be. We would point to some areas that stand out to us that could have broad market and economic impacts.

Corporate Income Tax Rates

In the reconciled version of the tax reform bill, corporate income tax rates were reduced to 21% from 35%, which wasn’t as low as in prior versions of the legislation but is still quite significant. It seems obvious that lower US corporate income tax rates would lead to higher net after-tax income for US companies, which would in turn boost the S&P 500 and other major market indexes. However, given the significant differences between companies’ current effective tax rates, the after-tax net-profit impacts of the tax bill will in reality vary considerably from company to company.

A reduced tax rate on repatriated foreign earnings and mandatory back payment on those past earnings will likely lead to a larger quantity of foreign cash coming home to the United States. That repatriation of cash could lead to possible increases in share buybacks, dividends and US domestic capital expenditure (capex). Capex could also get an additional boost from accelerated depreciation.

Many observers are also optimistic that tax reform will be the key to boosting US economic growth. Overall, we believe the tax legislation could stimulate higher US gross domestic product (GDP) growth, but we would have to make some positive assumptions. The Goldilocks scenario is where the combination of lower corporate tax rates, more repatriated foreign earnings, and accelerated depreciation all lead to higher US domestic capital spending, which in turn contributes to a faster pace of economic growth going forward.

That said, the factors influencing economic growth are complex, and taxes are only one aspect.