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Tax Reform As We See It

After being signed into law by President Trump last week, Tax Reform is now a reality. As a result, we felt it appropriate to convey what we see as the defining characteristics of the bill, as well as what it may ultimately mean for the markets.

The two most talked about corporate provisions of the tax bill are the decreasing of the marginal rate from 35% to 21%, and the one-time tax repatriation holiday which will likely bring billions of dollars into America from overseas. While we think these are clear tailwinds to corporations, we also feel there are other corporate tax reforms that could have just as large of an impact.

These include a move closer to the “Territorial Tax System”, which should help to solve the problem of international cash repatriation in the future. Also included is a cut to the pass-through tax rate that many family-owned or closely-held businesses are taxed under.

Significant changes were made to the individual tax code as well. Structurally, the tax bill appears to incentivize not itemizing deductions. This is done through several changes to the code including doubling the standard deduction, capping the deductibility of state and local taxes, and eliminating interest deductions on HELOC’s (Home Equity Lines of Credit). In another notable item, 529 plans have been expanded to allow tax-free distributions for elementary and high-school expenses. We anticipate that a consequence of the capping of deductibility for state and local taxes will be a strengthening of migration to zero income tax states like Florida, which have already been experiencing strong population growth.

Also of note, two provisions in earlier versions of the bill that were met with significant pushback were not included in the final bill. These are keeping “above-the-line” deductions of student loan interest, and tuition reduction or “forgiveness” remaining a non-taxable event. Both of these would have had negative implications for higher education had they been implemented.

Pivoting toward economic and market implications, we believe the tax bill is nearly certain to increase nominal economic growth. However, the question remains whether this growth can occur without simultaneously increasing inflation, which has largely been dormant since the financial crisis. With the Stock Market at all-time highs, we believe that much of the initial impact of the tax bill has already been priced in. But, in the long-run additional gains may accrue to companies that use their tax savings in the most productive manner. Gains could continue across the board as well if inflation remains muted.

Early anecdotal evidence appears to indicate that companies will invest at least a portion of their tax savings into their businesses and employees with AT&T announcing a $1,000 bonus for all domestic employees. Comcast, Boeing, and Wells Fargo also all promised increased wages as a result of tax savings.

These anecdotes reinforce our opinion, which is shared by our good friend Brian Wesbury, Chief Economist at First Trust Advisors, that a dollar in the private sector or in the public’s hands is nearly always more productive than one held by the government. As a result, while no bill is perfect, and this one like all others is certain to have negatives, we look favorably upon this needed update to the corporate and individual tax code. Please be advised to consult with your CPA or professional tax advisor as to how each tax payer may be individually affected.

We thank you for the trust and confidence you have placed in our team this year and look forward to continuing our work for you in the coming year.

Wishing you and yours a Merry Christmas and a Happy New Year,

The Allen – Albritton – Houghton – Elmhorst Group