With the possible exception of Sunday’s thrilling Super Bowl, President Trump’s policies will continue to garner the most attention from investors this week. Here we discuss the top Washington policies to watch in 2017. Look for updates from us on these topics in the weeks and months ahead as we get more information.
Border tax – The tax plan from the House of Representatives includes a provision that essentially taxes imports and not exports in order to encourage U.S. production. Although the proposal could be a big source of tax revenue (potentially $1 trillion over 10 years) to help offset the cost of corporate tax cuts, we do not expect this plan as proposed to make it through Congress, partly due to the outsized impact on certain industry groups such as retailers. Even President Trump himself has been skeptical due to the tax’s complexity. A watered down version, however, would not surprise us.
Capital expensing – To incentivize capital investment, tax reform may include a provision to allow immediate depreciation of capital expenditures. Bigger up-front depreciation depresses companies’ taxable profits, thereby lowering their tax bill. This measure, which stands a reasonable chance at approval, would boost U.S. manufacturing if enacted.
Corporate tax rate – A lower corporate tax rate has bipartisan support. The current rate (35%) is one of the highest in the world and encourages companies to move overseas. Bringing the rate down, potentially to 25% (although Trump and Republicans in Congress have suggested lower), would help keep U.S. companies from moving offshore, boost corporate profits and almost certainly boost U.S. economic growth.
Energy reform – President Trump has already signed executive orders to enable pipeline construction and encourage more oil and gas production. We expect more energy reform measures as domestic oil and gas reserves provide significant opportunities to achieve the Trump agenda of creating jobs and stimulating U.S. manufacturing.
Financial services reform – President Trump took the first big steps in reforming financial services regulation with executive orders last week to begin to overhaul Dodd-Frank—the post-financial crisis Wall Street reform legislation—and to delay implementation of the Department of Labor’s fiduciary rule for financial advisors. Overhauling the entire financial services regulatory framework will take a lot of time, but the end result is likely to be more lending, which is good for the economy and markets, and less friction in capital markets. The downside is of course the possibility we are sowing the seeds of the next crisis.
Foreign trade – A possible trade war with China or Mexico is perhaps the biggest risk to markets in 2017. We think cooler heads will prevail and we will end up with only targeted and temporary tariffs as has been used by recent administrations including G.W. Bush and Obama. Our bias is that the administration will enact protectionist trade policies but they will result in only a modest negative impact on the U.S. economy. That said, Trump’s actions on this front are difficult to predict. If you pay attention to one item on this list in terms of economic policy, this is it.
Healthcare reform – Healthcare reform may be as difficult to predict as trade policy. President Trump has already issued an executive order to begin an overhaul of the Affordable Care Act (ACA), but it is still very much unclear what a replacement will look like. The elimination of taxes and penalties associated with the law is very likely, but the fate of those covered by the ACA remains very much in limbo. This process will take over a year and probably more than two.
Immigration policy – The President’s controversial immigration policies have the potential to impact the U.S. economy and markets in several ways. We could see a tighter labor market which could lead to unwanted inflation and pressure on profit margins. Our labor force may be less productive and less innovative (particularly in the technology sector which relies heavily on foreign talent). And we could see a more polarized electorate that could make collaboration across party lines even more difficult on a variety of fiscal policies.
Infrastructure – President Trump has proposed $100 billion per year in infrastructure spending via public-private partnerships. Bipartisan support makes some sort of program likely but we are skeptical that this level of spending will be achieved given the two big constraints: 1) the supply of attractive revenue-generating projects is limited; and 2) the deficit hawks in Congress will demand spending restraint and revenue offsets.
Interest deductibility – Eliminating the deductibility of interest on debt is another way to help pay for lower corporate tax rates. Current tax policy enables companies to deduct the interest paid on their debt to lower their tax bill. This deduction does not incentivize desired behavior (we do not necessarily want companies to be overleveraged) and loopholes must be closed to help pay for tax cuts; so although it may be politically messy, we believe this provision stands a reasonable chance of being enacted.
Repatriation – Another policy with bipartisan support, a lower tax rate for companies to bring cash back from overseas would generate additional tax revenue (the cash is otherwise trapped) and likely drive additional capital investment, as well as shareholder friendly dividends and share repurchases. Again, tax revenues must be raised to offset lost revenue from a corporate tax cut making this policy very likely.
So there you have it, our top Washington policies to watch. Much more to come on these topics throughout 2017.