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What tax reform may mean for markets
Some version of tax reform is likely to emerge out of Washington during President Trump’s early months
in office. Many of the ideas that have been proposed by the White House or the GOP-led Congress would
have wide-ranging effects on the economy and financial markets. While there seems to be no shortage of
politicized opinions in today’s partisan climate, an honest, unbiased discussion of the possible reforms can
help investors set expectations for the potential impact the changes may bring to the financial markets.
Potential tax reforms could produce a tailwind
for stocks
$
$
$
Proposed reforms could boost economic growth
in the near term
Any tax reform outcome would create winners
and losers among sectors and asset classes
Potential tax reforms could produce a tailwind for stocks.
Potential tax
reforms could
produce a
tailwind for
stocks.
• A reduction in the corporate tax rate is estimated to have a significant impact on after-tax earnings per share
(EPS) for S&P 500 companies (see chart below).
– Dropping the corporate tax rate from the current 35% to 20% (as House Speaker Paul Ryan has proposed)
would result in a 7.2% increase in S&P 500 EPS, estimates Ned Davis Research.
– A 15% corporate tax rate (as Trump had proposed as a presidential candidate) would result in a 13.9%
increase in S&P 500 EPS.
• A simplification of personal tax brackets and reduction in personal income tax rates would likely bolster
consumer confidence and encourage spending.
• Proposals for repatriation of deferred profits held overseas — either a one-time low-rate tax holiday or an
extended period of tax breaks on these profits — could potentially fuel a new round of share buybacks and
merger activity among multinational companies.
Chart 1: After-tax income per share under proposed corporate tax reform plans
n Current effective tax rate
(25.4% corp. tax)
$120
$98.8
$104.9
n Ryan proposal
(20% corp. tax)
$92.1
n Trump proposal
(15% corp. tax)
$80
$55.4
$58.9
$46.5
$40
$15.9
$21.5
$22.8
Large companies
(S&P 500 Index)
Mid-cap companies
(S&P 400 Index)
Small-cap companies
(S&P 600 Index)
Ryan proposal (20% tax)
7.2%
19.1%
35.4%
Trump proposal (15% tax)
13.9%
26.6%
43.9%
% change in after-tax income
Sources: S&P Capital IQ, Ned Davis Research Group
Capital market insights | 2
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$
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Proposed
reforms could
boost economic
growth in the
near term.
Proposed reforms could boost economic growth in the near term.
• Lower corporate and personal tax rates would put more money in the hands of individuals and businesses,
potentially boosting consumer spending and business investment.
• The overall impact on the economy from lower tax rates would be positive but modest; consumer spending
has been robust in the past few years, and the unemployment rate is not likely to fall much further from
current levels.
• Options to pay for tax reform are diverse, but it is more likely that the fiscal deficit will rise as a result.
– The Border Adjustment Tax proposal would potentially offset some of the loss of revenue from corporate
and personal tax cuts, and could fall more heavily on companies that sell a large portion of imported
goods in the U.S. or manufacture some or all of their products overseas (see illustration below).
– Ending the deductibility of interest expenses would also help pay for some of the tax reduction proposals,
making leverage and debt issuance less attractive for companies.
Chart 2: How a proposed Border Adjustment Tax may affect manufacturers and retailers
U.S. companies making
goods in the U.S. can
deduct production
costs from income
U.S. companies selling
U.S.-made goods
overseas would not
count these sales as
taxable income
U.S. manufacturer
U.S. companies selling
U.S.-made goods in the
U.S. would count these
sales as taxable income
U.S. retailer
OPEN
Overseas retailer
OPEN
U.S. companies selling foreign-made
goods in overseas markets would not
count these sales as taxable income
U.S. companies selling
foreign-made goods
to the U.S. market
would count these
sales as taxable income
Overseas manufacturer
U.S. companies making
goods overseas cannot
deduct production costs
from income
Capital market insights | 3
Any tax reform
outcome would
create winners
and losers
among sectors
and asset classes.
Any tax reform outcome would create winners and losers among sectors and
asset classes.
• Financial companies, many of which currently pay the highest corporate tax rates among S&P 500 firms,
would be among the biggest beneficiaries of a corporate tax reduction, according to an analysis by Strategas
Research Partners.
• Whatever form a repatriation proposal takes, technology companies stand to benefit the most because they
have the lion’s share of overseas cash among S&P 500 companies.
• In the proposals to pay for tax reforms, retailers and consumer goods companies would have the most to lose
from a border adjustment tax, as they are the largest importers of goods, but small-cap companies could
potentially benefit because they do more of their business domestically.
• Ending the deductibility of interest payments would fall hardest on energy and telecom firms, both of which
would likely see a significant impact on earnings from higher costs to service existing and new debt issues.
Chart 3: Possible winners and losers from proposed tax reforms
Possible winners
Possible losers
Financial stocks — If corporate tax rates are lowered
Retailers — If border adjustment tax is implemented
Technology stocks — If overseas profits can be
repatriated at lower tax rates
Consumer goods stocks — a BAT could have its
biggest impact on earnings for this sector
Small-cap stocks — Domestic business would be less
impacted by a border adjustment tax
Energy & telecom stocks — If interest expense
deductibility is phased out
Capital market insights | 4
Key takeaways
Washington is “open for business” as much as it has been in recent years, but few expect it will be business-as-usual with
President Trump in office. After a year when the unexpected became reality, it’s foolish to regard any legislative proposal as
improbable or unlikely. For investors, that requires an honest and unbiased assessment of the potential impacts of all reform
ideas emerging from the White House or Congress. There remains a great deal of political wrangling yet to be done over what
tax reform will look like, so pay attention to the final outcome rather than the ongoing rhetoric.
• Review the tax reform proposals with an unbiased eye, focusing on the details of the changes and not the accompanying
political pronouncements.
• Maintain balance in your portfolio allocation as winners and losers are sorted out in the final tax reform changes.
• Keep a long-term time horizon when investing and avoid snap investment decisions based on political and legislative
developments.
For more help or information, contact your financial advisor.
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