- In this Timely Topics, we take a look at a few of the implications of the final tax bill.
- The new law is intended to boost economic activity and simplify the U.S. tax code.
- Given clarity on the new tax law, we are raising estimates for U.S. GDP and S&P 500 operating earnings for 2018.
After more than a year of political posturing and investor anticipation, Congress finally approved a $1.5 trillion tax cut, the most sweeping U.S. fiscal overhaul since 1986. The 2017 Tax Cuts and Jobs Act was signed into law by President Trump last Friday, December 22, meeting his pledge to deliver tax reform before Christmas. The complex 1,000-page bill features changes that are intended to spur economic activity through a reduction in both individual and corporate tax rates, and simplify the tax code by eliminating or trimming a variety of deductions and exemptions. In this special commentary, we look at the likely impact of the final bill on the economy, monetary policy, and the financial markets in the coming years.
As we wrote in our Outlook 2018: Return of the Business Cycle publication, the combination of improved business fundamentals and fiscal legislation should sustain momentum in the economy and equity markets in the coming year and potentially beyond. After years of depending on the largess of monetary policymakers, investors can now focus on fiscal levers that we believe will support consumption and spur new business investment over the next few years. The law has important implications for major corporations, small businesses, and individual taxpayers [Figure 1], and may shift the trajectory for economic growth, the federal budget, monetary policy, and perhaps most critically for investors—corporate profits.
ECONOMY & THE FEDERAL RESERVE
Though much of the political posturing over the past year was a result of the reduction in corporate tax rates, the legislation offers a larger than expected boost to individuals. While higher income earners should experience the largest benefit, the breadth of the individual tax rate reduction may lead to higher levels of consumer spending over the next few years. For example, in 2018, the net tax cut is set to exceed $100 billion, and as the effects of the alternative minimum tax (AMT) changes settle out in 2019, the consumer windfall could eclipse $200 billion, or approximately 1.0% of gross domestic product (GDP). Of course, the goal of lawmakers is that the increase in consumption will have a positive feedback loop, generating increases in output, employment, income, and ultimately, tax receipts. Alas, without an increase in productivity, the gains in personal spending are unlikely to be permanent, which is another reason leadership in Washington, D.C. included incentives for business investment as part of the tax package.
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Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate, and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
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Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.
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