Tax Reform Winners & Losers

The reflation trade has waxed and waned since November along with expectations for U.S. tax reform but any tax reforms this year should only reinforce a reflationary environment already in place before the U.S. presidential election. Significant uncertainty shrouds the final tax plan, and the need to find offsetting revenue means tax reform will create winners and losers.

Written by Richard Turnill (BlackRockBlog.com)

...Assets likely to benefit from rising growth and inflation aren’t contingent on U.S. corporate tax reform, yet such reform does have the potential to amplify this market theme.

Median effective U.S. corporate tax rates, 2016

Sources: BlackRock Investment Institute and Bloomberg, February 2017.

Notes: The bars show median effective corporate tax rates based on firms' latest fiscal-year earnings releases. Mega caps are the top-10 largest firms in the S&P 500 as measured by market cap. Mid caps are represented by the Russell Mid Cap Index and small caps by the Russell 2000 Index.

One example: We see reflation supporting more gains in U.S. small cap stocks. They typically outperform during periods of rising rates. Tax cuts would be an extra boost disproportionately benefiting small caps, given those corporations’ higher effective tax rates.

Tax Reform Winners and Losers

The border tax adjustment would effectively subject imports to a 20% tax to help pay for any corporate tax cut. Proponents argue the U.S. dollar should rise in response, offsetting the impact on trade or consumer prices. We see only a partial currency adjustment, which could help exporters and hurt retailers and consumers. How the U.S. dollar behaves in such a scenario will be key for markets and the U.S. economy.

We also believe another proposed reform, scrapping the deductibility of interest expense, would ultimately hurt highly leveraged companies and have major implications for how companies finance themselves in capital markets. Without offsetting revenue, large corporate tax cuts would increase the deficit, creating a reflationary stimulus that could lead to higher interest rates. We see potential for volatility in the coming months as more reform details emerge....