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Vontobel Viewpoints - Less Taxing Times

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Written by: Douglas Bennett, Senior Portfolio Advisor, Vontobel Quality Growth Investment Team

Over the past two decades, U.S. corporates would have readily agreed with the words of the American broadcaster Arthur Godfrey who once quipped, “I’m proud to be paying taxes in the United States. The only thing is, I could be just as proud for half the money.” To those corporates’ delight, in the weeks after Thanksgiving the two houses of the U.S. Congress voted for a major overhaul of the corporate tax structure. And on 21 December 2017 President Trump signed into force the Tax Cuts and Jobs Act amending the Internal Revenue Code “to reduce tax rates and modify policies, credits, and deductions for individuals and businesses.”1

As of 1 January 2018, the statutory federal tax rate on U.S. companies declined from 35% to 21%, and the combined rate, federal (national) plus subnational, fell thereby to roughly 27% vs. the previous 38.9%. Even though the old average effective rate was below the statutory 35% - probably by several hundred basis points - this new rate brings down the U.S. corporate rate to a significantly more competitive level vs. other countries. It is one that is now lower than the OECD weighted average of 30%, where previously it sat on top (see chart to the right).

The tax reduction will lead to higher corporate profits in three ways. First, the lower tax rate could add over $13 (10%) to after-tax EPS estimates for 2018 consensus estimates for the S&P 500, bringing the total to almost $1482. Second, existing overseas profits can be repatriated over time at a reduced 15.5% tax rate, that is, they can be brought home progressively at a lower rate under the new “territorial scheme” vs. the old global system. These profits can then be more efficiently allocated by being invested in future growth, or allocated to higher dividends or share buybacks. And third, the U.S. economy should grow faster with the lower corporate and personal tax rates that should provide new incentives for working and investing. Economists have estimated at least a 50 bps additional increase in GDP growth for 2018 and the ensuing several years.

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1 H.R.1 – 115th Congress (2017-2018), congress.gov.
2 Clifton, Dan, Strategas, 5 January 2018; Yardeni, Edward, S&P 500/400/600 Annual Earnings, 4 January 2018, yardeni.com.