Head - NAM Investment Strategy
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At $1.5 trillion over ten years, we expect the bill to provide modest late-cycle economic stimulus
On 22 December, President Trump signed the tax bill into law. The centerpiece of the tax reform is a reduction in the corporate tax rate from 35% to 21% to make US businesses more competitive. A 21% rate brings US corporate tax rates more in line with other developed countries and below the rates of China and Mexico. Potential tax cut winners have outperformed since the election and especially since late September when tax cuts moved to the top of the fiscal policy agenda.
Businesses should also benefit from accelerated depreciation of new investments, lower taxes on pass through income and a modified territorial tax system for multinational companies where firms are taxed based on where they generate business. There will be a one-time tax on current un-repatriated foreign earnings. However, the interest deduction for
businesses will be limited to 30% of business income to discourage firms from taking on too much leverage.
The next most important feature of the tax reform plan is to roughly double the standard deduction on single and joint filers. The idea is to simplify the tax process and curb reliance on itemized deductions. In 2015, 69 percent of filers took the standard deduction, according to data journalism website FiveThirtyEight, an amount that should only climb. In addition, the Wall Street Journal recently reported that just 200,000 or so filers are now expected to pay the Alternative Minimum Tax
(AMT) versus millions beforehand.
The reform repeals the individual mandate penalty of the Affordable Care Act (ACA) which was being paid by about 6.5 million filers, according to the IRS. These filers will no longer pay a penalty but the repeal is also likely to bring about higher costs for those keeping their health coverage and lead to a greater number of people who find they can’t afford coverage at these new higher prices. The Congressional Budget Office estimates 13 million fewer people will be insured in the next 10 years.
We believe tax reform is discounted in the market at this time. 10-year Treasury yields have climbed to 2.50% and the US stock market ended the year on a high note.
The global investment committee (GIC) estimates S&P 500 earnings per share (EPS) growth of 11% in 2017 and 6-7% in 2018 before tax cuts; 9-10% growth in 2018 now looks reasonable. Look for research analysts to revise their 2018 earnings estimates upward. Historically, analysts have over-estimated earnings at the start of each year but this pattern may be
upended in 2018 by the timing of the tax cuts
At a price tag in the neighborhood of $1.5 trillion over ten years, we believe tax reform will provide some late-cycle stimulus to the US and global economies. This, in turn, could put a higher floor under the US dollar from what might have otherwise been the case. Longer-term, a lower after-tax cost structure with accelerated depreciation schedules may encourage some
firms that sell their products into the US to produce more in the US.