Congress recently passed the “Tax Cuts and Jobs Act” and President Trump signed the bill days later. The package passed on party lines with no Democrats supporting the measure. The real question is how does this affect us and the way we invest? Regarding stock prices, it appears as if tax reform was baked in as of last Monday. Stocks stagnated in the latter half of the week even after the bill’s signing. P/E ratios are at historic highs and it is unlikely the market will continue to ride higher unless there is another catalyst.
Perhaps the most important part of the bill is slashing the corporate tax rate from 35% to 21%. We essentially went from being one of the highest taxed nations in the world to being about average. According to taxfoundation.org the average global marginal tax rate is 22.6%. This makes the U.S. competitive, opening the floodgates for new investment. Already, companies like Boeing, Comcast, Wells Fargo, and AT&T are announcing bonuses, pay raises, and investments in the U.S. economy. In addition, international economists are in panic over the loss of foreign direct investment.
I recently read two articles out of Canada and Germany. Both had the same conclusion. They argue, the U.S.’s favorable regulatory environment, abundance of labor, and low cost of land already create inventive to invest. The only factor keeping companies out was the 35% tax rate. When you slash the rate to 21%, nothing will be holding companies back from entering the U.S. They go on to explain how this trend could crush Germany’s and Canada’s economy. You can read one of the articles here.
Other changes made include personal income tax reductions for over 80% of Americans. The new rates have been lowered to 10, 12, 22, 24, 32, 35, and 37. The standard deduction was doubled and some of the previous tax deductions were scaled back. For instance, individuals can only deduct up to $10,000 of state and local taxes. This could negatively affect upper income individuals in higher taxed blue states. Even so, the legislation keeps current deductions for student loan interest, and individuals can now deduct medical expenses exceeding 7.5% of AGI. Furthermore, the bill eliminates the Obamacare individual mandate in 2019, increases the child tax credit to $2,000/child, and eliminates the alternative minimum tax for corporations.
The U.S. is already at 3.2% GDP growth, as of last quarter. This bill could push the U.S. closer to 4% and perhaps even 5%. These numbers have huge implications for investors, particularly domestic companies. Overall, lower individual tax rates typically lead to higher consumer spending. The business tax cuts promote investment, wage increases, and job growth. And although we still have to worry about interest rate hikes and North Korea, the future looks pretty bright. In any case, we are getting a tax cut and are able to keep more of our hard earned money. Merry Christmas everyone!