Odds of Tax Reform Increase Significantly

The U.S. Senate passed a tax overhaul bill Saturday morning. We now believe the chances are above 90% that major tax reform legislation will be passed into law. The two versions of legislation will now be merged into one by a formal conference committee of Senators and Representatives. While some changes are yet to come, we believe the two versions are close enough for us to comment on our expectations of what tax reform will mean.

Corporate taxpayers appear to be the biggest beneficiary of this reform. Any business with primarily a domestic presence should see their tax bill decline. This includes most small and medium size business, as well as Fortune 500 companies that focus on the U.S. This will include Haverford portfolio holdings such as Comcast, CVS Health, and Verizon. We calculate a reduction in Comcast’s federal corporate tax rate to 22% will result in a 21% increase to 2018 earnings.

Middle class taxpayers from most states should receive a tax cut. It appears that everyone believes his or her individual taxes are going up. We do not see that as being the case. Many taxpayers will benefit from the near doubling of the standard deduction and child tax credit. It is true that high earning residents of high tax states will likely see an increase in their tax liability. But these individuals are most likely also business owners and equity investors who stand to benefit from higher corporate earnings and asset prices.

Investors should benefit not just from the obvious positive reaction we have experienced in the stock market, but also from the long-term effects that a more rational tax code will have on business decisions. We have long discussed the estimated $2 trillion of corporate earnings that are stranded overseas. The barriers to repatriating foreign earnings could be greatly minimized.

Consumers should also benefit. The U.S. vibrant and market-driven economy should also adjust to lower tax rates. The near-term effects should drop directly to corporate bottom lines, but over time we believe that some of the corporate benefits will be competed away in the form of lower consumer prices.

Tax reform will most likely add to economic growth. The most controversial debate surrounding the legislation is its long-term effect on our economy’s growth trajectory. Those philosophically opposed to tax reform believe its growth effects will be nil, and vice-versa. We believe that any legislation that incentivizes corporations to make business decisions versus tax decisions is inherently good for the economy.

Stronger economic growth and increased inflation expectations will nudge the Federal Reserve to normalize monetary policy more quickly. We believe the odds of three rate hikes in 2018 increases with the passage of this bill.