The new tax law and investing

The new tax legislation will result in some modest increase to GDP growth in 2018—but there will be other financial factors that influence the market’s growth as well. Vanguard’s Global Chief Economist Joe Davis explains.

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Rebecca Katz: Do we feel that the trickle-down underpinnings of the new tax bill is valid? What do we think the impacts of the new tax bill will be? So, we’re kind of, I know we try to be apolitical, but there is some—

Joe Davis: So I’ll just give the economic reading and the simulations we’ve done. This is a politically charged issue, but that said, I’m going to answer the question.

Rebecca Katz: We represent millions of people of all different political views.

Joe Davis: Yes, again, first of all, the “final” tax bill legislation, it’s not finalized because the House and the Senate plan have to be rectified. But let’s say there’s a general reconciliation of those two. Our simulations, and just as importantly, those that I’ve seen from bipartisan commissions whose full-time job it is to score and estimate the economic impacts on GDP growth, on employment, inflation for various legislative changes, this is actually mandated by Congress to my understanding.

So I think there will be, if the current law was passed, a marginal but positive modest impact to GDP growth, roughly 30 or 40 basis points. So what that would mean, if growth has been averaging 2% in GDP as a frame of reference, maybe 2.5%. Ironically, if we get 3% growth, there’s a similar question, so modest. That’s just an economic thing. I think there are some things that are important for the United States to see on a relative comparison and that would be a simplified and more competitive corporate tax, so I think that’s one of the primary benefits.

Ironically, if we see stronger growth in 2018, this is not a political statement. If we see stronger growth in 2018, my argument would be it does not necessarily have to come at all from the tax reform package because we are now at a level of unemployment in the United States, believe it or not, that is only roughly 4%. And it’s only at this time, so economists generally make the argument, when the economy’s at full employment, it tends to slow down because there’s no more workers to find. That’s actually not true. What you find is that when you approach full employment, you tend to have the incentive for businesses to invest more in their business, either hiring but also new planned equipment, computers and so forth.

So I bring up investment spending because that has been the relative deficiency in this recovery for the United States for the past several years. Consumers have been spending almost at the same rate as they were before the global financial crisis, believe it or not. The engine that’s been a little bit weaker has been business investment. So, ironically, if we get a stronger than expected economic environment for the U.S. in 2018, it could in part because of business investment, regardless of the details of the tax plan come out.

Rebecca Katz: Elizabeth in Riverside County did say, “If there’s a corporate tax cut, which we’re talking about, how do we know that would be job growth? Wouldn’t the corporations just continue to build up cash?” Which, there are many corporations sitting on a lot of cash.

Joe Davis: There is a great deal of cash. Some of it’s overseas. However, most of that is concentrated in a handful of companies, in a handful of industries. You know, there has been, higher than in the past, say before the global financial crisis, the earnings that are being generated by companies, a greater percentage has been used through dividend buybacks or through share repurchases, what some will call financial engineering. Sometimes there’s a good reason for companies to do that and a little bit less on the CapEx [capital expenditure] side. That’s why I bring up CapEx, because that leads directly through to GDP perspective.

I think we’re at the stage of the business cycle where we may see this thread start to improve, in part because we’re going to see some rising wage costs, which is good for the economy, but I think it changes the calculus that some companies at the margin may be doing over the next year or two.

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