Taxing Concerns

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by: Neuberger Berman

By Joseph V. Amato

"In this world, nothing can be said to be certain except death and taxes." -Benjamin Franklin

It's been over 30 years since the last major corporate tax reform in the U.S. Perhaps now, with a Republican White House proposing a tax reform agenda and a Republican Congress, it might actually be achieved.

The proposals currently on the table include significantly reducing the corporate tax rate: President Trump wants to reduce it to 15%; Congress, led by House Speaker Paul Ryan, is shooting for 20%. However, the tax initiative also includes provisions that the market is more wary of, such as the border adjustment tax (essentially an import tax) and a reduction in interest deductibility for corporate debt.

The process of getting all this done may require using the process of "reconciliation" contained within the 1974 Budget Act. This enables a simple majority within the Senate to approve the tax changes, thus eliminating the 60 votes necessary to avoid a filibuster. However, the legislation would lapse after 10 years if it adds to the U.S. budget deficit.

So what do we believe is achievable?

While we broadly agree that tax reform is an overdue necessity, we believe a more modest set of tax changes will be the end result. It is widely known that the U.S. corporate tax rate (at essentially 39%) is among the highest in the world and puts U.S. companies at a competitive disadvantage. Getting the statutory tax rate down to 15% or 20% will either require other revenue sources or will meaningfully increase the budget deficit. The border tax adjustment, for example, is poised to raise approximately $1.2 trillion over 10 years (as estimated by The Tax Policy Center); however, many are dubious of the revenue generation or otherwise oppose the adjustment. We think a package of more modest tax changes that get the statutory rate into the mid- to high 20% range is doable and would positively impact corporate earnings.

The final proposals are also likely to include a reduced tax rate for the repatriation of overseas cash, which we believe will provide a boost in corporate buyback activity. U.S. companies currently have approximately $2.5 trillion of cash sitting outside of the U.S. Under the current tax code, that cash, if brought back, would be taxed at a very high rate. If, however, that rate were lowered to 10%, we expect many companies would take advantage of this provision.

No Time to Lose

So when this might happen?

The legislative process takes time and there are many details still to be determined. The process of then reconciling proposals among the White House, the House and the Senate will be arduous. As a result, we may be looking at late 2017 or early 2018 before a bill is actually passed. Any later than this and Congress will become embroiled in their midterm elections, when often little gets done.

Historically, this president has appeared relaxed about debt. Indeed, he has regularly used it to fund his own business empire. But it's a different matter when it comes to getting legislation through Congress. The success or failure of the current tax proposals, therefore, may depend largely on how far the conservative wing of the Republican Party will go in maintaining some level of fiscal discipline within the budget.

As President Trump passes the milestone of his first 100 days in office, some in the media have commented on his low approval ratings, but it's worth reminding ourselves that, early in his first term, President Bill Clinton's ratings were also at a then-record low. Yet, when he left office eight years later, he had the highest approval ratings of any president since the Second World War. There are still plenty of opportunities for the new president to make his mark. His tax initiative may be one of them.

In Case You Missed It

  • Case-Shiller Home Prices: February home prices increased 0.7% month-over-month and 5.8% year-over-year (non-seasonally adjusted); +0.2% month-over-month (seasonally adjusted)
  • U.S. New Home Sales: +5.8% to SAAR of 621,000 units in March
  • U.S. Consumer Confidence: -4.6 to 120.3 in April
  • U.S. Durable Goods Orders: +0.7% in March (excluding transportation, durable goods orders decreased 0.2%)
  • U.S. 1Q17 GDP (first estimate): +0.7% annualized rate
  • Eurozone Consumer Price Index: -0.1% in April month-over-month and +1.9% year-over-year

What to Watch For

  • Monday, 5/1:
    • U.S. Personal Income & Outlays
    • ISM Manufacturing Index
  • Wednesday, 5/3:
    • ISM Non-Manufacturing Index
    • FOMC Meeting, Summary of Economic Projections and Press Conference
  • Friday, 5/5:
    • U.S. Employment Report

- Andrew White, Investment Strategy Group

Statistics on the Current State of the Market - as of April 28, 2017

Market Index WTD MTD YTD
Equity
S&P 500 Index 1.5% 1.0% 7.2%
Russell 1000 Index 1.5% 1.1% 7.1%
Russell 1000 Growth Index 2.0% 2.3% 11.4%
Russell 1000 Value Index 0.9% -0.2% 3.1%
Russell 2000 Index 1.5% 1.1% 3.6%
MSCI World Index 2.0% 1.5% 8.2%
MSCI EAFE Index 3.1% 2.6% 10.2%
MSCI Emerging Markets Index 1.7% 2.2% 13.9%
STOXX Europe 600 4.5% 3.8% 11.8%
FTSE 100 Index 1.3% -1.3% 2.3%
TOPIX 2.9% 1.3% 1.8%
CSI 300 Index -0.8% -0.5% 4.0%
Fixed Income & Currency
Citigroup 2-Year Treasury Index -0.1% 0.1% 0.3%
Citigroup 10-Year Treasury Index -0.3% 1.2% 2.0%
Bloomberg Barclays Municipal Bond Index -0.4% 0.7% 2.3%
Bloomberg Barclays US Aggregate Bond Index -0.2% 0.8% 1.6%
Bloomberg Barclays Global Aggregate Index 0.0% 1.1% 2.9%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.1% 0.4% 1.2%
BofA Merrill Lynch U.S. High Yield Index 0.6% 1.1% 3.8%
BofA Merrill Lynch Global High Yield Index 0.9% 1.5% 4.6%
JP Morgan EMBI Global Diversified Index 0.4% 1.5% 5.4%
JP Morgan GBI-EM Global Diversified Index 0.2% 1.2% 7.7%
U.S. Dollar per British Pounds 1.3% 3.5% 4.7%
U.S. Dollar per Euro 1.9% 1.8% 3.2%
U.S. Dollar per Japanese Yen -2.1% 0.0% 4.6%
Real & Alternative Assets
Alerian MLP Index 0.3% -1.3% 2.6%
FTSE EPRA/NAREIT North America Index -3.0% -0.2% 0.2%
FTSE EPRA/NAREIT Global Index -1.4% 1.3% 4.7%
Bloomberg Commodity Index 0.1% -1.5% -3.8%
Gold (NYM $/ozt) Continuous Future -1.6% 1.4% 10.1%
Crude Oil (NYM $/bbl) Continuous Future -0.6% -2.5% -8.2%

Source: FactSet, Neuberger Berman.

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