WHEB Commentary

Ted Franks

Monthly Commentary: December 2017

We saw some rotation during December with profit taking in a number of 2017’s best performing names, but the biggest news arrived early in the month. In the early hours of Saturday 2nd, the US Senate voted to pass the “Tax Cuts and Jobs Act”. This was the last real hurdle to passage of the bill. On Friday 22nd, President Trump signed it into law.

The ‘Trump Tax Reform’, as it is now known, is quite a remarkable piece of legislation. Firstly, it has huge scope: it touches nearly every part of the tax code. The last reform of comparable size was in 1986[1], and before that 1964[2].

Secondly, it will hugely increase the US fiscal deficit. The proposed tax cuts aren’t nearly matched by spending cuts. According to the nonpartisan Joint Committee of Taxation, it will add around $1trn[3] to the deficit over the next decade. This is even after accounting for economic growth. Such profligacy flies in the face of one of the supposed guiding principles of the Republican Party which sponsored the bill.

Thirdly, it is notably unpopular with the general public. Since at least 1981 no American tax bill has been less popular. In that time in fact there have been two tax rises that were more popular than the Trump cuts[4].

With the observations above, and current political climate, it should come as no surprise that the bill gathered no votes from the opposition Democratic Party. This is another unusual quality for a bill of this importance.

All this adds up to bad policy, and bad policy tends not to last. But for now, the clear winner is the corporate world. The biggest single headline of the reform is a cut to US corporate tax rates to 21%. This from a current highest possible rate of 39.1%[5].

Taxes are real. They are paid from real cash flow. So cutting tax rates certainly should be positive for shareholders. Some of that cash saved from taxes will flow straight to them. Some of the rest will go into further productive capacity to spur further growth (although how much remains contentious).

This is at least part of the reason that we are seeing such strong equity markets at the moment. Of course, co-ordinated global economic growth is helpful too.

For those of a short term bent, it is possible to bet on the outcome of tax reform efforts. The Trump tax plan is very complex and not all the details are clear yet. But it is a good rule of thumb that US companies with high domestic exposures and high tax rates will benefit the most.

Sustainability meanwhile is by definition a global imperative. The majority of our companies have global operations. They pay corporate tax rates that reflect this i.e. a blend of the rates of the countries they operate in.

With our long term lens, we would rarely trade around policy reforms like this anyway. We try to understand companies’ tax rates, and this plays a role in our assessment of companies and their attractiveness as investments. However, tax issues alone are unlikely to sway our investment decisions. As real as taxes are, with a five year horizon, growth prospects and company quality are a bigger deal. So that is where we will continue to invest.

[1] 1986 Tax Reform Act see e.g. https://www.brookings.edu/blog/fixgov/2017/09/27/back-to-the-future-reagan-trump-and-bipartisan-tax-reform/

[2] The Revenue Act of 1964 see e.g. https://en.wikipedia.org/wiki/Revenue_Act_of_1964

[3] Macroeconomic Analysis of the Conference Agreement for H.R.1, The “Tax Cuts and Jobs Act” 22 December 2017 https://www.jct.gov/publications.html?func=startdown&id=5055

[4] Source: fivethirtyeight.com https://fivethirtyeight.com/features/the-gop-tax-cuts-are-even-more-unpopular-than-past-tax-hikes/

[5] CBO e,g, https://www.investopedia.com/news/trumps-tax-reform-what-can-be-done/