BLACKROCK INVESTMENT INSTITUTE

Tax overhaul winners and losers

15/jan/2018
By BlackRock

Key points

  1. We see the US tax overhaul boosting growth, lifting interest rates and creating winners and losers from lower top rates and closing of loopholes.
  2. US Treasury yields hit 10-month peaks and equity markets notched more record highs. Oil prices rose on signs of tightening supply.
  3. Chinese fourth-quarter gross domestic product (GDP) data will set the tone for the country’s growth expectations and policy priorities for 2018.

Tax overhaul winners and losers

The Tax Cuts and Jobs Act is poised to boost a US economy already running at full capacity. A windfall from lower taxes and incentives for capex could spur more consumer and business spending and corporate deal-making. A likely convergence in tax rates could create winners and losers, rippling across sectors and companies.

Chart of the week
US equities effective corporate tax rates, 1980-2017

Chart of the week

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Thomson Reuters and Compustat, January 2018.
Notes: We take data from financial statement for Russell 1000 companies to arrive at an effecrive corporate tax rate at the company level (tax expense divided by pretax income). The lines show the effective tax rates of 75th percentile of tax payers and 25th percentile over time. The dotted line shows the federal statutory rate.

A 30-year rewind is informative. In the decade following the 1986 US tax reforms, companies paying a relatively high share of their income in taxes saw their effective tax rates drop. Low effective tax payers saw a small rise as reforms leveled the playing field and closed loopholes. Effective tax rates started diverging again in the late 1990s as globalisation, the adoption of territorial tax systems and relatively high top US tax rates encouraged tax avoidance schemes. We believe something similar may play out today. The top quartile of US companies currently pay an effective tax rate of 34% or more, our analysis shows. This leaves plenty of room for relief as the top rate is slashed to 21%. Lightly taxed companies, by contrast, may see their rates go up over time.

Looking beneath the surface

The overhaul of the US tax code includes supply-side reforms and injects significant near-term demand stimulus into a US economy running at near-full employment. A faster-growing US may accelerate global growth, and result in rising inflation, higher Treasury yields and steeper yield curves. Look for a deep dive into how the tax changes and potentially higher US government spending may affect the economy and interest rates in our upcoming Global macro outlook.

The tax cuts create winners and losers in the corporate sector. The drop in the top statutory rate will broadly benefit US companies with high effective tax rates. But some of the benefits for these companies appear to be priced in already, suggesting investors need to look beneath the surface to identify the longer-term winners. There is significant dispersion within industries, sub-sectors and companies. The sustainability of increased corporate profitability derived from tax cuts will also vary. Companies in highly competitive industries, for example, will likely see a temporary profit boost that is quickly competed away. Changes to companies’ spending and investment plans because of the tax law are key details to watch through the fourth-quarter earnings season. We expect US global corporations to scrutinise the new tax code’s complex international rules in an effort to manage any rises in their effective tax rates.

In credit markets, we see investment grade companies benefiting from lower tax rates. Yet we see most of the impact going to shareholders rather than toward paying down debt. High yield companies benefit from lower tax rates and immediate expensing of capex. But we expect more bifurcation between higher- and lower-quality issuers, as ones with large debt loads face limits to interest expense deductibility. This reinforces our up-in-quality credit stance. Municipal bonds emerged relatively unscathed, even as advanced-refunding bonds lost their tax-exempt status. This is set to shrink issuance, a factor we see supporting valuations.

 

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  • Global bond yields climbed, with 10-year US Treasuries hitting 10-month highs. US interest rate volatility picked up, partly on reports, later denied, that China was planning to slow its Treasury purchases. Strong retail sales and inflation data in the US also pushed yields higher.
  • Global equities marched on as US banks kicked off the earnings season. Banks’ projected tax rates were lower than expected, but trading revenues remained sluggish. A breakthrough in German coalition talks and hawkish minutes from the European Central Bank (ECB) underpinned euro strength.
  • Oil prices rose to 2014 highs on US inventory reductions and OPEC commitments to maintain cuts through 2018.

 


Date: Event
Jan. 17 US industrial production/td>
Jan. 18 China Q4 GDP, fixed-asset investment, retail sales
Jan. 19 International Energy Agency report

We are watching fourth-quarter Chinese GDP closely for hints on the country’s growth trajectory and policy priorities. The latest set of manufacturing and services data suggests China ended the year on a high note. Official Purchasing Managers’ Index (PMI) readings have caught up with the BlackRock Growth GPS. We expect a mild deceleration in China to a more sustainable growth pace. Inflation remains stable, leaving the central bank enough room to maintain its monetary stance while curbing credit growth and pushing for deleveraging within the economy.

Managing Director, is Global Chief Investment Strategist for BlackRock
Richard Turnill is Global Chief Investment Strategist for BlackRock. He was previously Chief Investment Strategist for BlackRock’s Fixed Income and active ...

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