On Dec. 22, 2017, history was made. For the first time in more than three decades, a sweeping overhaul of the U.S. tax code was signed into law by President Donald Trump. Known as the Tax Cuts and Jobs Act, this law fulfilled a key promise during Trump's campaign to pass along tax cuts to working Americans and corporations in an effort to boost growth for the U.S. economy.
Although you can read about what the Tax Cuts and Jobs Act does in greater detail, the main gist is that it lowers the corporate peak marginal income tax rate to 21% from 35%, as well as adjusts the income brackets and/or federal marginal tax rates for individual taxpayers, resulting in many expected to owe less in federal income tax in 2018 and beyond. The idea here being that corporations with more disposable income will use that money to hire, expand, and pass along better wages. In turn, given that approximately 70% of U.S. GDP derives from consumption, more taxpayers having extra cash on their hands could lead to improved GDP figures via an uptick in consumption.
Image source: Official White House Photo by Shealah Craighead.
Is Trump's tax reform flopping?
Initially, the stock market seemed pretty thrilled about the passage of the Tax Cuts and Jobs Act. But as of Wednesday, Oct. 24, the iconic Dow Jones Industrial Average and broad-based S&P 500 (^GSPC 0.02%) were down about 1% since Trump signed the bill into law. This raises the question: Has the Republican tax reform failed investors?
The good
In some ways, things couldn't be better for the U.S. economy. According to the September jobs report from the Bureau of Labor Statistics, the U.S. unemployment rate ticked down to 3.7%, which is its lowest reading in nearly 49 years. Understandably, the labor force participation rate has been on the decline, so this does have some bearing on the unemployment rate. Nevertheless, it would appear that the job-market turnaround experienced during the Obama presidency has continued, if not accelerated, during the Trump presidency.
Speaking of growth, U.S. GDP growth saw a dramatic uptick during the second quarter. With corporations able to bank more in comparable profits than in previous years, and taxpayers able to keep more of their wages (and presumably spend some of it), the year-over-year GDP growth rate came in at 4.2%. This is the fastest GDP growth since the third quarter of 2014.
Publicly traded stocks have seen a windfall of profits, too. Data from Thomson Reuters found that per-share profits for S&P 500 companies during the second quarter rose by 24.8% from the prior-year period. This was the second-fastest year-over-year EPS growth in S&P 500 stocks since late 2010, eclipsed only by per-share growth in the sequential first quarter of 2018. In other words, investors are apparently getting the data they expected (i.e., higher corporate profits).
Image source: Getty Images.
The bad
Then again, the Republican tax plan has had its fair share of unintended consequences. Topping that list was the assumption that corporations would use their extra income to hire new workers, lift wages, and expand their businesses. Instead, most of this cash is being funneled into share repurchases, fatter dividends, or simply being put under the mattress, so to speak. The real issue being that the federal government can't control or dictate what businesses do with their extra income.
Earlier this year, Just Capital analyzed the responses of 137 of the Russell 1000 companies pertaining to what they planned to do with their extra income. A mere 7% offered plans to use their added windfall for wage increases and/or one-time bonuses, with another 19% suggesting they'd use their extra income for job creation. By comparison, 57% planned to put this added profit to work by repurchasing common stock or increasing their dividend.
Data from CNN proves even more damning. During the second quarter, publicly traded companies repurchased an all-time record $436.6 billion worth of their own stock. The next-highest amount? That'd be $242.1 billion in buybacks, which was hit in the sequential first quarter of 2018. In short, the two largest quarters of corporate buybacks in history have occurred since the Tax Cuts and Jobs Act was signed into law.
Image source: Getty Images.
The honest answer: It's too early to tell
So, which is it: Did the Republican tax plan fail investors or not?
The honest truth is that we simply don't know yet. For as much evidence as we have on both sides of the coin, the fact remains that it takes time before the success or failure of a fiscal stimulus like the Tax Cuts and Jobs Act can be determined. Typically, when a fiscal stimulus the size of the Tax Cuts and Jobs Act is signed into law, it'll be a good 18 to 24 months before its success or failure can be determined.
What is clear at this point is that it's not a complete failure, as it does appear to be having an upward effect on corporate profits, and it's not a complete success, as this extra corporate income isn't going where Republicans hoped it would. Over the next year, we'll get some added clarity and be able to make a more accurate determination of whether the largest tax overhaul in more than three decades finds its mark.
