Investors have expressed concerns about how the proposed tax overhaul by the new US administration would benefit companies as Donald Trump’s radical policy rhetoric takes centre stage.
After much hype on the back of the long-debated economic plan set out by the new US president during his election campaign, a new corporation tax cut plan was announced in April, leaving many wary of what the changes would actually mean for firms.
Trump’s plan would see the US corporate tax rate cut from 35 per cent to 15 per cent and the tax on repatriated offshore earnings cut to 10 per cent from the current 35 per cent.
He has also suggested reducing the number of individual income tax brackets from seven to three with rates of 10 per cent, 25 per cent and 35 per cent.
The move is set to simplify the US tax system, slashing taxes for large and small businesses, as well as ditching inheritance taxes.
However, according to lobbying group Americans for Tax Fairness, a 20 percentage point cut to corporate tax rates alone would add $2.4tn to the national debt.
America’s federal debt currently stands at nearly $20trn, or 105 per cent of GDP, which is a record high. This, coupled with the expectation inflation and interest rates will gradually rise, decreases the likelihood a vote of confidence on the reform.
Hermes US SMID Equity fund lead portfolio manager Mark Sherlock says the reduction in the tax is likely to prove “politically unachievable” but he argues over time there will be some beneficial changes in tax policy to sustain the domestic economy.
James Thomson, manager of the Rathbone Global Opportunities fund, says the change in the tax rate should not be the reason for investor optimism based on the effect it would have on the country’s deficit.
He says: “We believe Donald Trump’s tax proposals will be heavily rowed back, particularly when the debate hits the Senate. Senators have a rebellious streak and some of the most dramatic Republicans are also the most fiscally conservative who hate big government spending programs.
“Trump’s spending spree would triple the deficit; this would require a monstrous U-turn from the same senators.”
However, if the changes go through, Trump would operate in a very different environment than that of former president Ronald Regan, who similarly cut taxes, according to AJ Bell investment director Russ Mould.
He says: “Trump has a lot less room for manoeuvre than Ronald Reagan, to whom he is regularly compared for his tax-cutting and deregulating zeal. Whereas when Reagan took office in 1981, inflation and interest rates were falling, federal debt was low and US stocks were cheap after a vicious bear market, Trump is taking control at a time when interest rates and inflation look to be rising, albeit slowly, federal debt stands at record levels and US stocks look expensive relative to their history after an eight-year bull run.”
With the S&P 500 up 11 per cent since Trump’s election, the opposition in Washington and the efficiency of American corporation tax now might not be a good time for Trump’s big policy move.
Mould notes that US corporations are already paying historically low amounts of tax leading to an increase in their profit margins.
US companies’ tax bills represented just 7.5 per cent of pre-tax profit and 3.4 per cent of sales in 2016, according to Federal Reserve data.
Mould says: “A cut in the US corporate tax rate to 15 per cent from 35 per cent, assuming this is proposed and then delivered, is likely to add 1.5 percentage points to corporate profit margins, using that 3.4 per cent tax paid-to-sales ratio as the starting point.
“On a total company sales base of $15.6trn, that is the equivalent to around $225bn, or 13 per cent of the aggregate post-tax profits made by corporate America in 2016.”
While the overall market may not benefit from the proposed new policy, there are bound to be winners and losers.
Thomson notes that just after the US election in November, the companies with the highest tax rates “massively” outperformed, but since December have given all the gains back.
He says: “Reliable growth stocks have recently come back into favour, while businesses that would do very well from tax cuts and infrastructure spending have fallen back. Interestingly, technology companies have been the stand-out performers year to date, with the Nasdaq surpassing 6,000 for the first time.”
Thomson says confidence is running high among several technology giants on the west coast of the US.
He says: “The US is unlikely to grow as fast as Trump hopes, but it is still expanding comfortably. Consumer and business confidence is strong and the housing market appears to have plenty of runway too. We hold about 60 per cent of our portfolio in the US and the volume or make-up hasn’t changed since Trump’s election.”
Sherlock says small and mid-cap stocks, which typically pay a higher rate of corporate tax, are more likely to benefit from any repatriation of overseas dollars.
In particular, Sherlock mentions software developer Manhattan Associates as a potential winner.
He says: “The predictable negative headlines and sentiment provided us with a long-awaited opportunity to invest in Manhattan Associates. [It is] a consumer brand exposed to competition but a business that is both enabling and benefitting from the growth of omni-channel sales.”
Michel Perera, chief investment officer at Canaccord Genuity Wealth Management says stocks are likely to react positively to the change in the policy but warns the “fine print” of the legislation will ultimately define which companies will benefit from it.
In the case a deal on the new tax reform can be agreed by Congress, the Senate and the White House, Perera argues highly-geared companies could sell off, whereas multinationals could do well on the repatriation tax in particular.
Perera says: “If [the legislation] is designed to be revenue neutral, there should be as many losers as winners so the overall market move won’t be euphoric, but stock and sector specific.
“US Treasury bonds may sell off if the bill is not totally revenue neutral, as more debt would have to be raised. The US dollar would only react positively if there was an effective repatriation tax reduction. Although most of the $2bn sitting overseas may be brought back, the vast majority is already in dollars.
“Nevertheless, the sheer size of the conversion into dollars might propel it higher. It looks like the currency market is already anticipating some of this, as the dollar has picked up
versus both the euro and the Japanese yen. If there is a let-down, the dollar would be the first