Tax Reform: Impact on Businesses, Wall Street and Individuals

By Ron Insana, CNBC Senior Analyst and MB Contributor

Tax reform analysis

President Trump and Congressional Republicans celebrated the passage of the tax reform bill on Wednesday, December 20, saying the first major overhaul of the tax code in three decades will be a boon to corporate America and the working class.

While the working class may or may not benefit, it’s quite clear that corporate America has reason to cheer its passage. Immediately upon passage of the tax reform bill, FedEx dramatically raised its profit estimates for next year, citing not only a strengthening economy but also a large benefit from lower tax rates. AT&T said it would give its employees a $1,000 bonus once the president signs the bill. Other firms have hinted that they may do something similar. 

As the stock market’s rapid rise has suggested, it appears corporate America will, indeed, be the biggest beneficiary once this law goes into effect. But not all industries will benefit equally or in the same manner.

Analysts say the biggest winners, clearly, will be those with the highest “effective” tax rates ( largely domestically-focused businesses). These businesses would benefit mostly from the drop in tax rate from above 30%, down to 21%, or even potentially lower. This would include retailers, financial firms, oil and gas refiners, some oil exploration companies, industrial firms and select technology companies.

Of course, not all retailers are safe investments, even with lower tax rates. Some of them, facing fierce competition from the so-called “Amazon Effect,” will be adversely affected.  A tax rate of zero will not be able to save the retailers most vulnerable to on-going disruption. That is true of any individual company, by the way. Careful stock selection is, and always will be, of paramount importance irrespective of changes in taxes and regulations.

Other firms like technology companies which hold large cash hordes overseas (think Apple), would get a one-time benefit from bringing that cash home at a 15% tax rate. Still, other companies, like software and hardware firms, would get an economic boost from other companies that receive a large tax benefit from upgrading their plant, equipment or computer systems.

The Microsofts, Oracles and SAPs of the world, along with industrial equipment suppliers, will likely see increased sales of their products as companies rush to take advantage of “immediate expensing” for purchases of productivity-enhancing machinery and systems.

Auto companies, who lobbied hard to keep the $7,500 tax incentive to buy electric vehicles, also benefit. And it’s not just the Tesla effect at work here. The major auto companies are all re-tooling their assembly lines to roll out electric, or hybrid, versions of many of their vehicles in the next few years, so they too will get some help from the retention of this tax break.

It’s much harder, at least at the moment, to predict how small businesses and individuals on Main Street will fare. Many small businesses are comprised of sole proprietorships, S Corporations and LLCs. These so-called “pass-through entities” will see their taxes fall, but accountants I’ve spoken with say it’s too early to say by how much. Pass-throughs will get a 20% deduction on income that caps out at $315,000 for an entity run by a married couple, about half that for a single business owner. Beyond that, it’s tough to say how these small businesses will deal with the apparent complexities of the new code.

Accountants are already busy sharpening their pencils and putting on their green eyeshades to see how they might be able to take advantage of new and existing loopholes to further reduce taxes on small businesses.

Individuals may not fare nearly as well, especially those in lower and middle-income brackets. Besides relatively small cuts, the tax bill repeals the individual mandate which comprises the bulk of the Affordable Care Act, meaning many may not only lose subsidies that help them pay for health insurance, but may also lose their coverage altogether. Health insurance premiums, on average, are expected to rise at least 10% as a result, offsetting any tax benefit that individuals might enjoy from the new legislation.

Investors, however, will also be clear winners in this. Most companies say they will reward their shareholders before their employees, by repurchasing stock, raising dividends and acquiring other companies to create economies of scale. What’s less clear is whether the tax bill will boost economic growth so much that a rising tide lifts all corporate boats. Most economists estimate that tax reform will 0.3 - 0.4% to GDP growth in the next few years, though FedEx forecast a larger impact on the macro-economy, hence the revision to next year’s profit forecast. 

The key question at this juncture and analysts are split on this, is whether the stock prices of corporate beneficiaries have already “factored in” the impact of tax reform on their future profits. Stock prices have been up every month in the last twelve. The Dow Jones Industrial Average (DJIA) has scored 70 record closing highs this year, gaining more than 25%, while the NASDAQ is up more than 30% and the S&P 500 about 20%.

Stocks typically don’t rise on backward-looking data, but global growth has been surprisingly strong, corporate profitability has climbed to record levels, and a slightly weaker dollar has benefitted export-oriented companies, irrespective of the implications of tax reductions here at home.

While the investment implications remain a bit unclear, one thing is certain. In an environment where tax rates will be coming down, corporations appear to be the biggest beneficiaries of this new law. Investing in already established companies, with strong balance sheets, strong growth prospects and solid management could still be the way to win. That a big kick from tax reform in any of the above-mentioned industries is coming will just be icing on the cake in 2018 and beyond.

The views and opinions expressed in this article are solely those of the author and do not represent the view of MB Financial, its Board of Directors, employees or shareholders.