Key facts for investors
Impact on the economic cycle
The cyclical impacts of the Tax Cut and Jobs Act are fairly straightforward. First, the corporate tax cuts will positively impact corporate profits, and profits are a major driver of economic activity. We would argue that profits are at least as important as the consumer in economic impact, since most consumers owe their jobs and wages to the fact that they are employed at profitable companies. Researchers estimate the cut in the corporate tax rate from 35% to 21% will cut the effective rate paid by corporations by 3-6 percentage points. This will raise profits in 2018 by 7-12% over what they would have otherwise been. The profit improvement will tend to boost capex, wages, employment, dividends and share buybacks.
There is disagreement concerning how these profits will be used. We expect positive effects in all of the above areas, and initial public statements by a number of executives at major corporations support this. We will focus on the likelihood of capex growth, which some economists argue will not occur since an extended period of very low interest rates has not been effective in stimulating it. We point to several factors (not all inclusive) that should stimulate capex in 2018 even though we are likely in the latter stages of this economic cycle:
The secular story
We believe the most important story behind tax reform, and the one that should be of most interest to investors, involves its ability to boost the growth potential of the U.S. economy on a secular, or long-term, basis. Productivity is one of the two variables that determine potential GDP growth, the other being labor force growth. The size of the labor force is a given because it is determined by demographics. It is expected to grow at an average rate of just over 0.5% over the next decade.
Both variables have been sluggish in this economic cycle, leading to lower GDP growth potential (as well as low actual GDP growth). While labor force growth cannot be materially changed, economic policy can impact capital investment, which in turn can improve productivity. Improved productivity can drive higher potential GDP growth over many years. This is why the Tax Cut and Jobs Act is important. We are pleased to see economists and strategists raising their 2018 GDP forecasts to 3% or higher, a cyclical impact. We are much more encouraged that the major elements in this package provide the ingredients for boosting potential GDP growth in the U.S. by 1% or more for years to come. The investment implications of this are significant and positive for risk assets.
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