Congress recently passed and the President signed the most significant change in tax law in over three decades with the Tax Cut and Jobs Act. Staying away from the political aspects of the law we at Gate City Advisors want to explore the potential benefits and challenges it creates. While the initial design was to focus heavily on corporate tax relief, surprisingly there is a lot that impacts individuals. Let’s look at the major components for each group.
For Businesses: The key piece is the reduction of the corporate tax rate from a top rate of 35% to a flat rate of 21%. This makes the U.S. more competitive as we are more in line with the Organization for Economic Cooperation and Development (OECD) average now whereas we previously had one of the highest corporate tax rates. Other significant items include the elimination of the Alternative Minimum Tax (AMT), immediate deduction for certain capital expenditures, a low repatriation tax and change to a territorial tax system. In addition, there is a 20% deduction on personal income tax for pass-through income of small businesses.
For Individuals: While there are still seven tax brackets there is significantly more income that is now taxed below the 25% marginal rate, including a new lower 12% and 22% bracket. These lower brackets should help a lot of individuals as a majority of people will fall in this range. While the AMT wasn’t eliminated fewer people will be impacted by it. The standard deduction was nearly doubled. While the personal exemption was eliminated the child tax credit was doubled to $2,000. This will be a big benefit for families with young children as a tax credit has a much larger impact than a deduction of the same amount because it comes directly off tax owed. The big controversies are around the effect on itemized deductions by the cap of $10,000 on SALT (state and local tax) and the mortgage interest deduction applies only to mortgages up to $750,000. It could have a negative impact on charitable giving and housing as fewer people may be able to itemize than before.
Investment Implications: The net benefit seems to be positive for GDP growth over the next year or so. Estimates range from .30% to .60% additional growth annually in 2018 and 2019. It would also seem to support stock prices as lower tax rates impact valuations positively. The longer term challenge is whether the benefits will have a lasting impact. The aging baby-boom generations negative impact on labor and productivity growth is documented and may make it hard to maintain a higher GDP growth rate. In addition, some fear that fiscal stimulus at a time of low unemployment could lead to a reemergence of inflation and the potential of a recession if the Fed raises rates too quickly. It would appear that small businesses may fair better as they tend to pay higher tax rates relative to larger ones. In addition, higher taxed sectors such as telecom, industrials and financials may benefit.
SHERWOOD GREER, CFP®, RICP®