The Dividend Cafe - Santa Delivers the Most Market-Friendly Tax Cut In Over 30 Years - Dec. 22, 2017

Episode Date: December 21, 2017

Santa Delivers the Most Market-Friendly Tax Cut In Over 30 Years - Dec. 22, 2017 by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. Well, hello and welcome to the final Dividend Cafe podcast of 2017. We look forward to giving you all the up-to-date information this week, things on our mind, things primarily related to tax reform, and a handful of other investment topics that we think you're going to want to hear. But even more exciting for us than that is our commitment to 2018 podcast, completely revamping it, providing a whole new approach that will not just be our weekly recitation of the DividendCafe.com commentary,

but instead creating some fresh and midweek and all sorts of different, lengthier and more, I think, digestible and applicable investment commentary via our podcast. So all that to say, it's been an incredible year in 2017. We've enjoyed doing this. We certainly feel that our Dividend Cafe commentary that we published at DividendCafe.com has been a wonderful success and we get great feedback on it all the time. But we do think that the podcast is in need of some tweaks and we're going to do that. We're going to make it something that we think generates more value, primarily for our clients, but also for other listeners that are interested in our point of view. So with that said, let's close out 2017, getting ready to go into the Christmas holiday weekend with probably the greatest Christmas gift investors could have hoped for this year, and that is the final completion of this monumental and, dare I say, historic tax bill.

Very rarely have we seen a tax bill passed by a House and then passed by a Senate go into conference to be reconciled, and not just a tax bill, any bill for that matter, and come out better where there wasn't just push and pull and give and take. Generally, what you would have expected here in the tax case is compromise necessary to kind of get it passed. That would have watered down maybe some of the better provisions, things like that. In this case, I truly believe from a market standpoint, I'm not going to gauge what the political ramifications would be, but just in terms of the efficacy of generating growth and productivity out of this tax bill, which most economic actors have a vested interest in, and certainly we do as people obsessed with

the investment markets, I think that they did a tremendous job. How big of a deal is it? Let's put it this way. The tax cuts out of 2018 alone represent $205 billion, over 1% of GDP. This makes it on a percentage of GDP basis the second largest tax cut in history, second only to Reagan's world-changing tax bill of 1981. The Senate bill improved upon the stimulative nature of the House bill, and the final bill out of conference improved upon the stimulative nature of the Senate bill. Obviously, much of the benefit of this legislation has been priced into the stock market, evidenced by the significant add-on rally the market has seen in the last, let's call it, eight weeks.

add-on rally the market has seen in the last, let's call it eight weeks. Our take, the markets are pricing in much of the benefit of earnings per share growth that the corporate tax cuts automatically create, but the markets are not yet appreciating how much potential there is for real GDP growth embedded in this heavily supply-side reform legislation? Well, the CBO says, you know, the Congressional Budget Office has forecasted that there will be 2.2% real GDP growth in the years ahead. In 2003, the actual GDP growth post-tax cut was 1.2% higher than projected. 2004, 1.3% higher than projected. Put differently, the underestimate of GDP impact by CBO was over a trillion dollars in a three-year time period. So all that to say, do we believe that the CBO is getting it wrong again? Well, the CBO is in a very difficult position. They're trying to turn knobs and make projections on things that are somewhat unforecastable.

I do believe that when you look at the dynamic scoring of this type of stimulus, the automatic math of the tax cuts coming back into the private sector, and then a supply side effect, I think you're going to see meaningful increase to GDP growth, net of inflation that will be highly stimulative into the economy, generating greater productivity and greater growth. The most attractive parts of this tax reform from an investor standpoint, I mean, certainly the 21% corporate tax rate versus the present 35% rate greatly enhances corporate profitability for many companies, creating more free cash flows, greater opportunity for capital spending, growth initiatives, a more engaged labor

force, and stock buybacks, dividend payments. This huge reduction is significantly pro-growth, regardless of what one company does with this increase to their own cash flow afforded them by the reduced tax liability, it can only be better for investors than the current system, which is a distribution to the federal government. The 37% top rate versus 39.6% top rate for marginal personal income rates represents a 5% reduction on the margin for high earners. This rate reduction is slightly supply side but more significant because it offsets the impact of the loss deduction for state and local taxes. Immediate and full expensing for capital expenditures is a big, big deal. Small, privately held companies, family businesses, all the way up to large corporate conglomerates.

The long-missing ingredient in GDP growth of growing CapEx is likely to be much addressed by this incentive. Not to mention, it remedies one of the most convoluted and complicated parts of the U.S. tax code. The movement to a territorial tax system, which now avoids double taxation of U.S. companies with foreign profits, is not only common sense legislation, but extremely important towards modernizing the code and incentivizing global competitiveness. Now, what are some of the downsides for investors? Are there disappointments here that may be less attractive in the tax bill we want to look at? I think a lot of people were expecting the so-called Obamacare surtax of 3.8% on investment income to maybe be dealt with. That's a tax that kicks in for people over $250,000 in income that is added on the margin pretty punitively for capital gain and dividend income and so forth.

And high earners had hoped that this would be dealt with. It was not. The repatriation tax rate, the one-time tax hit in a holiday, so to speak, to get profits being held offshore back home, moved higher. And so it actually kind of progressively moved higher throughout the process. But the final number, instead of the 9% they were targeting, ended up being 15.5% for cash and 8% for illiquid assets. It's mandatory. Companies will be repatriating it whether they want to or not.

But excuse me, they'll be paying the tax whether they repatriate the cash or not. If they're going to pay the tax anyways, they have no motive not to repatriate. So we think it is heavily stimulative in that regard. Most S&P companies have already taken charges against this future liability, put reserves aside essentially that are larger than what the liability will be so uh we don't think it's going to have a negative impact earnings per share in the short term we actually think a lot of cases you'll end up having companies um with a positive impact earnings it will be accretive for future home purchases the mortgage interest on up to 750 000 of debt will be deductible it It's $1

million now. I'm really stretching to make this negative. I don't think it's going to have any impact at all. And I frankly would prefer to see that mortgage interest deduction go away altogether. But the reality is that it's not very politically popular to get rid of it. And so they met in the middle and said on new purchases going forward, the number will be $750,000. in the middle and set on new purchases going forward, the number will be 750. I do think that higher bond yields are very likely consequence of the greater growth that this tax bill will represent. I see that as a positive, not a negative. So we expect some higher nominal rates, and we can see interest rates going even higher into the future next year. They've already creeped up a little, but we're positioning bond portfolios and encouraging investors to consider in their real estate investments and things of that nature. Not just that interest rates can go higher,

but probably will. So if you go into DividendCafe.com, you're going to get to see more color on how it impacts municipal bond investors, what it means in the pass-through section of the tax bill, the impact to so-called S-corps, LLCs, partnerships, things like that. We have a little segment on China and what we're kind of envisioning going on there into 2018. going on there into 2018. And then I absolutely love the chart of the week showing the explosion in GDP growth back in 2003 and 2004 after the last tax cut bill was passed. So we really encourage you to read DividendCafe.com this week. I can't imagine a greater Christmas present than reading my investment commentary. Okay, maybe I'm stretching now. Well, for those of you who are so inclined, please do read there. Come back to us with questions you may have. We're always an open book. Love the

dialogue. Love the engagement. Most importantly, have a wonderful holiday weekend. A very Merry Christmas. And since we will not be doing the podcast next week, we encourage you to have a very happy new year. And then we come into 2018 revamped and ready. What an incredible year it's been. God bless each and every one of you. Thank you for listening to Dividend Cafe. Thank you for listening to The Dividend Cafe, financial food for thought. are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance

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