Markets wait to see if the tax reform man cometh

E*TRADE Securities2

04/11/17

If at first you don’t succeed…try tax reform. After the new administration’s decision to pull the health care reform vote, it shifted its focus to revising the nation’s tax structure. But as complicated as health care proved, trying to overhaul the tax code could prove considerably more difficult. The last time Congress passed a sweeping tax reform? 1986.  

Below, we highlight several tax proposals reportedly under discussion and consider what they could mean for the investing community.

  • A corporate tax cut could help the domestically focused. President Trump pledged to lower the corporate tax rate from 35% to as low as 15% during the campaign. Pundits note that companies with high effective tax rates could be in line to see a lower tax bill, especially those with most of their sales coming from the U.S., where companies face some of the highest tax rates in the world. They also note that more homegrown consumer discretionary, consumer staples, and industrials companies could benefit. Financials with limited international exposure may fall into this category as well. 
  • A border adjustment tax may hurt importing companies. Talk of a tax on imports, while exempting exports, has garnered market attention. The idea would be to encourage companies to produce goods at home. But opponents argue such a tax, known as a border adjustment tax, would unfairly hit those sectors that rely heavily on imported products—not to mention consumers, who could face pass-through costs. Retailers, including apparel and multi-line companies, may be in the crosshairs here, as well as automakers. 
  • A tax holiday could bring cash home. Many pundits expect some type of repatriation tax holiday (a short-term reduction or elimination of taxes) to encourage money earned overseas to come back into the U.S. at a reduced rate. Large multinationals would be the target audience here, as the current tax structure incentivizes these companies to stash their cash tax-free in subsidiaries abroad. The hope is that creating this window would bring cash home, spur investments in labor and equipment, and boost the economy overall. However, The New York Times1 notes that a 2004 tax holiday did not have the desired job creation effect. Rather, companies put some of their repatriation cash to work by engaging in more merger and acquisition activity.

Another big undertaking to consider

Talking about tax cuts is one thing. Implementing sweeping tax reform is another. It’s a huge undertaking that, if enacted, could have major implications across a variety of markets, sectors, and securities. Many predict that an overhaul of the tax code will require tradeoffs and concessions that could affect nearly every area of the economy. A revenue-neutral tax reform appears to be the goal of many in Congress, meaning there will likely be winners and losers. If tax rates are lowered, federal funding has to come from somewhere, so lawmakers will be looking for ways to make the math work. For individuals, some note that popular tax deductions, such as mortgage interest and charitable donations, could even be affected. Understanding how these potential changes could affect their long-term financial goals may be a wise move.

Putting policy news in perspective

Trying to stay on top of policy machinations in Washington is not an easy endeavor. One day it’s talk of a possible tax on imports, the next it’s something akin to a national sales tax or a tax on carbon emissions. The noise can become deafening, which is why we believe investors should focus on their long-term goals, time horizon, and risk tolerance, no matter what happens within the Beltway. Broadly diversified portfolios across asset classes and time horizons can help investors stay well-positioned for almost any development over the long term.

  

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1. de la Merced, Michael J. “The Great Overseas Cash Grab,” The New York Times, 5 Apr. 2017. https://www.nytimes.com/2017/04/05/business/dealbook/repatriate-corporate-cash-trump.html?_r=0