REPUBLICAN TAX REFORM POLICY COULD BE A GAME -CHANGER | Crouch Connection, February 2017

REPUBLICAN TAX REFORM POLICY COULD BE A GAME-CHANGER

Last month I promised to give you my perspective on the policies being circulated by the new Trump administration and the House Republicans. Fair warning, this letter may get a little deep, but stick with it. I believe the conclusions could be game-changing.

When the House Republicans, led by Speaker Paul Ryan and Ways and Means Committee Chairman Kevin Brady, presented their tax overhaul proposal, “A Better Way: Our Vision for a Confident America” in June 2016, no one believed it had a chance of gathering enough votes in Congress to become a reality. Tax reform has been discussed for years, with broad agreement that an overhaul is badly needed to reverse the policies that have helped create our enormous trade deficit, but discussions have always bogged down quickly when it came to sorting out the details,

That may have changed last week when President Trump showed interest in the House GOP’s “border adjustment” framework in a speech to congressional Republicans at their retreat in Philadelphia.

ONGOING TRADE DEFICITS TEND TO WEAKEN THE ECONOMY

A trade deficit is caused when the value of goods and services a country purchases from other countries exceeds the value of the goods and services it is able to sell to other countries. In other words, our purchases exceed our income.

Initially, it is nice to run a trade deficit because we can purchase goods from countries that can produce them cheaper than we can, and if we can purchase those goods with borrowed money, our standard of living magically appears to go up. But therein lies one of the problems: As a country, we cannot have a trade deficit unless other countries are willing to loan us the money needed to fund the excess purchases.

Since 1975, the United States has accumulated the world’s largest trade deficit in history and our trade deficits have gotten us to a huge net foreign debt of $7.8 trillion, taking an entire percentage point out of our economic growth over the last two years, according to Dr. Michael Ivanovitch, former international economist at the New York Federal Reserve Bank in a CNBC Op-Ed this week. He says, “America’s trade problems are urgent and vitally important policy issues.”

In addition to the debt issues, trade deficits cause jobs to be lost to countries with a lower cost of living, which can produce those cheaper goods and services. In my opinion, this is what has caused the uprising which led to the election of Donald Trump as President.

THE POTENTIAL GAME-CHANGER

According to the Tax Foundation. the House GOP tax reform proposal would change the current corporate income tax in five major ways:

The tax rate would be lowered to 20% (from 35%). In addition to the obvious boost to company profits, this provision would eliminate the current incentive companies have to consider moving to countries with lower tax rates.
Business would no longer be required to pay U.S. income tax on income they earn in other countries. This eliminates another provision that most other countries do not have.
Businesses would no longer be required to depreciate capital investments over 3, 5, 10 or 20 years. Instead, they would be allowed to fully expense, or write off, those expenses in the year they are purchased. More on this one later.
Businesses would no longer be able to deduct interest as a business expense. Over the long run, this helps offset the cost for numbers 1, 2, and 3, but with interest rates currently very low, is not a back-breaking cost to most businesses.

The corporate income tax would be “border-adjusted”. This is the potential game-changer. The “border adjustment” means that if a business purchases (or produces) goods or services in another country, the cost of those goods or services would not be deductible against the corporate income tax!

In other words, a business would be required to pay taxes on 100% of revenue received for products produced in another country, not just on the profit earned! This would make it very difficult for imported products to compete with American-made products.

PUTTING AMERICA FIRST!

If the GOP plan is passed, American businesses would suddenly have a huge incentive to produce all of their products in the United States and purchase all of their materials and services in the United States. Combined with the other provisions, the proposal could produce a huge building boom in the U.S. as manufacturers gear up for the increase in domestic production.

There would be winners and losers in this new reality, and suddenly coalitions are being formed to either support or oppose the tax reform proposal. The American Made Coalition supporting the proposal includes Dow Chemical, General Electric, Boeing, Merck, Pfizer and several other U.S manufacturers who stand to benefit from the plan. On the other hand, retailers including Wal-Mart, Target, Nike and Gap have formed their own group to fight the plan, as retailers who import most of their goods stand to lose the most under the plan.

In addition to the apparel retailers, oil refiners who import foreign oil would be at a substantial disadvantage while the U.S. shale oil producers would have another advantage over the foreign oil producers. U.S. steel and aluminum producers would finally have a substantial advantage over the foreign producers, which have been dumping their products into the U.S. for years at prices below their costs, supported by government subsidies.

American auto manufacturers would finally have a big advantage over the foreign manufacturers, although the plants the Japanese, Korean and German companies have built here will help them somewhat. Toyota, which imports about half of the1.2 million cars they sell in the U.S. each year, is organizing their dealers to protest the changes, while Honda, which produces 68% of their U.S. sales in U.S. plants, is in a better position. Ford comes out best with 79% of vehicles sold in the U.S. built in the U.S., while Volkswagen would suffer another blow with only 12% of the vehicles sold in the U.S. built in their Chattanooga plant, their only U.S. plant according to a Bloomberg report

"We've, net, bought $12 billion of common stocks since the election"

Warren Buffett

WRAP-UP

Even though it is far from certain that the proposal will become reality, we believe that it is important to understand this proposal and the impact it could have on any investments we may be considering. In our opinion, the most likely outcome will be somewhat less impactful than the current proposal, but we will be “peeling back the layers of the onion” and looking at the new tax policies and their potential effects company by company.

President Trump’s immigration policies could also have a significant impact on markets if they are rolled out as currently discussed, but I believe those will be adapted to the needs of our businesses before adoption. Feel free to call if you have any additional questions.

Sincerely,

Dave Crouch

Financial Advisor

Registered Principal

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Dave Crouch and not necessarily those of Raymond James

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Dave Crouch and not necessarily those of Raymond James.