There has been a significant amount of news coverage on US House Tax Reform Blueprint over the last several weeks. Both the new presidential administration and the Republican-controlled Congress have publicly opined prioritization of corporate tax reform. With the likelihood of an aggressive tax reform plan increasing, Wall Street is clamoring to establish how the proposed changes will impact the market as a whole and individual sectors.
At the end of last week, JP Morgan published an in-depth report on the possible impact of the current proposed tax reform, which includes a change in domestic statutory tax rate, move to territorial tax system from worldwide, adoption of border adjustment tax, interest rate deductibility, and expensing of business investments.
JPM: Tax Plan Could Boost S&P 500 EPS By $8
As there are so many moving parts here, it’s difficult for even JP Morgan’s analysts to come up with an accurate assessment of what proposed changes will mean for the market as a whole. What’s more, as the plan has yet to be finalized a certain number of assumptions need to be made. The key assumption in JP Morgan’s case is that the US dollar remained relatively unchanged from current levels and corporates are able to pass through around 75% of the proposed border tax onto end customers.
- Overall, JP Morgan’s analysts estimate that the combined proposed changes could lift S&P 500 earnings per share by $8 in aggregate. There are five key building blocks to this scenario:
- The federal corporate tax rate drops from 35% to 20% and a territorial tax system is adopted. These changes will boost S&P 500 earnings per share by $16
- A border tax adjustment on imports of 20% at the federal level will deduct 8% from earnings per share
- Expensing of Capex (versus depreciation) will create $300 billion of net present value if federal corporate tax rate is 20%. The impact in the first year would be $26 billion.
- The removal of interest expense deduction would cost $245 billion net present value of which $2 billion would be felt in the first year
- A tax holiday, cash repatriation would create an additional potential $1.30 boost to earnings per share from buybacks.
These changes won’t benefit all sectors equally. In some cases the incremental cost of border taxes will outweigh the benefit from the rest of the tax plan. For instance, some of the largest US refiners suggest a proposed 20% border tax would raise gasoline prices by 15% presenting a $45 billion per annum headwind for consumers. Meanwhile, low margin retailers would need to raise prices mid-single digits on average to offset the border tax (JP Morgan estimates Walmart would have to hike prices by 9%).
Overall, the Financial sector is likely to benefit the most from the proposed changes listed above. JP Morgan is forecasting an 18% lift to earnings per share after factoring in the above. The sector that is least likely to benefit will likely be Energy with an expected decline in earnings per share of 4% if the tax plan covered above comes into force.
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