the Republican income tax plan and the stock market

The general outline of the Trump administration’s proposed revision of the corporate and individual income tax systems was announced yesterday.

The possible elimination of the deductability from federally taxable income of individuals’ state and local tax payments could have profound–and not highly predictable–long-term economic effects.  But from a right-now stock market point of view, I think the most important items are corporate:

–lowering the top tax bracket from 35% to 20% and

–decreasing the tax on repatriated foreign cash.

the tax rate

My appallingly simple back-of-the-envelope (but not necessarily incorrect) calculation says the first could boost the US profits of publicly listed companies by almost 25%.  Figuring that domestic operations account for half of reported S&P 500 profits, that would mean an immediate contraction of the PE on S&P 500 earnings of 12% or so.

I think this has been baked in the stock market cake for a long time.  If I’m correct, passage of this provision into law won’t make stock prices go up by much. Failure to do so will make them go down–maybe by a lot.

repatriation

I wrote about this a while ago.  I think the post is still relevant, so read it if you have time.  The basic idea is that the government tried this about a decade ago.  Although $300 billion or so was repatriated back then, there was no noticeable increase in overall domestic corporate investment.  Companies used domestically available cash already earmarked for capex for other purposes and spent the repatriated dollars on capex instead.

This was, but shouldn’t have been, a shock to Washington.  Really,   …if you had a choice between building a plant in a country that took away $.10 in tax for every dollar in pre-tax profit you made vs. in a country that took $.35 away, which would you choose?  (The listed company answer:  the place where favorable tax treatment makes your return on investment 38% higher.)  Privately held firms act differently, but that’s a whole other story.

 

The combination of repatriation + a lower corporate tax rate could have two positive economic and stock market effects.  Companies should be much more willing to put this idle cash to work into domestic capital investment.  There could also be a wave of merger and acquisition activity financed by this returning money.

 

 

 

 

One response

  1. Pingback: What stocks to invest in = the Republican income tax plan and the stock market « PRACTICAL STOCK INVESTING | Stock Investing

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: