All Posts

Trump’s Tax Plan – A Game Changer For The Markets

Trumps Tax Plan – A Game Changer For The Markets
Do more with what you’ve earned.

Financial advisors for successful professionals, executives, and business owners.

President-elect Trump has promised to create over 25 million jobs over the next decade and to boost the U.S. GDP to an average rate of 3.5%. He plans to do so by reducing both corporate and personal income tax rates, cutting regulation and government spending, renegotiating trade deals, promoting American-sourced energy, and rebuilding the American infrastructure (well, at least $1 Trillion worth). In this blog post, I focus only on Trump’s tax plan. Market risks have shifted and there now exists a real chance that there will be a positive fiscal change (finally), which will ultimately help drive economic growth. I believe this is a game changer to both the stock and bond markets.

Trump’s Corporate Tax Change

Let’s begin with Trump’s proposed business tax policy. Simply put, Donald Trump hopes to lower the tax rate from 35% (at the upper end) to 15% across the board. There will be no more tax brackets nor a corporate alternative minimum tax.

Trump’s Tax Plan – A Game Changer For The Markets
Trump’s Tax Plan – A Game Changer For The Markets

Furthermore, Trump is also attempting to bring ashore the massive amount of U.S. company cash hoard, estimated to be $2.5T (CNBC). That is nearly 14% of the U.S. GDP! He is hoping to repatriate this cash at a one-time tax rate of 10%, which I suspect a lot of corporations will act upon.

Why is this tax policy such a big deal? The market is finally going to receive a more friendly fiscal policy. Since the end of the Great Recession, we have only had monetary policy to count on to help drive demand/growth. But now, it looks like we can finally count on fiscal help in the form of tax cuts.

Trump’s Corporate Tax Change – Impact To The Markets

It is no secret that the stock market is extremely expensive with a P/E ratio of 25.36. (I have written about this topic here if you are interested in learning more.) We are currently near record valuations as the S&P 500 has reached all-time new highs since Trump was elected president.

Trump’s Tax Plan – A Game Changer For The Markets

But what does a Trump presidency mean for stock valuations? A lower corporate tax rate obviously means that corporations will be able to keep more of their profits. But how much more? What does this do to the market’s valuations? This is a more complicated question that it seems as there are a lot of factors driving the market. However, I attempted to quantify the change.

To better estimate the potential change, I figured it would be best to see how a lower tax rate would’ve affected the S&P 500 in the recent past (previous 12 months). Here are the facts:

  • The S&P 500’s Net Margin (Earnings/Sales) is 7.68% (TTM – June ’15-’16)
Trump’s Tax Plan – A Game Changer For The Markets
  • While the corporate tax rate is 35% (highest bracket), the effective tax rate is 28% (Deutsche Bank)
  • The earnings yield is a low 3.94% and the TTM as reported current P/E ratio is an astronomical 25.36!
Trump’s Tax Plan – A Game Changer For The Markets
  • The S&P 500 receives 33% of it’s profits from abroad, which means those profits are taxed at a different rate (blended 22.60%)

I highly suspect that Donald Trump will be able to pass a business tax rate of 15%, even with a Republican House and Senate eager to pass this law. Chances are, a rate closer to 20% will be pushed through. Nonetheless, the implications of a rate cut of this size are significant.

Trump’s Tax Plan – A Game Changer For The Markets

This 2.01% to 5.36% increase in S&P net margin brings the current net margin from 7.68% to 9.69% and 13.04%. In short, I believe this is what is currently driving the stock market higher. It is an immediate boon to the S&P’s bottom line.

The next question I asked is how this change would’ve affected the S&P 500? Let’s assume that Trump is able to pass a tax rate of 20% and the corporate earning’s margin is now 13.04% (up from 7.68%). That means that the S&P 500 earnings will increase from $86.92 to $147.55 per share.

The Stock Market Return With A Tax Cut

To better comprehend the implications of a business tax cut like this, I put together a sensitivity analysis showing the effect of a tax cut and the different P/E ratios. These numbers are as of 11/25/16.

Trump’s Tax Plan – A Game Changer For The Markets

Trump’s Proposed Individual Tax Policy

With a Republican-led House and Senate, Trump has a real shot at reforming the US tax code, which hasn’t been overhauled since 1986. As it currently stands, the highest federal tax bracket stands at 39.6%.Here is how the federal individual income tax code looks:

Trump’s Tax Plan – A Game Changer For The Markets

If you live in California, the highest state income tax rate stands at 13.3%, making the grand total 52.9% (39.6% + 13.3%). At this rate, the U.S. has one of the highest income tax rates in the developed world, behind only Belgium, Finland, Sweden, Aruba, and Canada. We are taxed to death here in California, especially those at the higher end of the spectrum. As such, corporate and individual earnings has been finding ways around these high income tax rates (legally and some not-so-legally).

The goal for the U.S. is to stay competitive in the global economy. Though, this is an economy that has been slowing for a number of years. The Federal Reserve and it’s monetary tools has been doing everything within it’s power to spur demand. But this tactic can only work for so long. A revamp of the current tax code can really change things. And if anybody knows the U.S. tax code and it’s failings, it’s the man that has used and abused it for the past 30+ years.

Here is Trump’s proposed individual tax rates:

Trump’s Tax Plan – A Game Changer For The Markets

Under this plan, most individuals will pay less in taxes. Though, not everybody will save the same percentage amount. In fact, according to the Tax Policy Center, higher earners will save more than those at the lower brackets.

Trump’s Tax Plan – A Game Changer For The Markets

Other changes in Trump’s Plan include:

  • Carried interest would be taxed as ordinary income
  • The 3.8% Obamacare tax would be repealed
  • The alternative minimum tax would be repealed
  • The standard deduction would be increased from $12,600 to $30,000 for joint filers, $15,000 for single filers
  • Personal exemptions will be eliminated
  • The head-of-household filing status will be eliminated
  • Itemized deductions will be capped for joint filers at $200K ($100K for single filers)
  • The death tax will be repealed, but capital gains held until death and valued over $10 million will be subject to tax. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.
  • Childcare expenses for those under the age of 13 will be allowed as a deduction. This includes stay-at-home parents, grandparents, and paid caregivers. The Trump Plan also will allow Dependent Care Savings Accounts (DCSA), which will allow contributions to be free from taxation.

Bottom Line

Trump has yet to take the office and these tax cuts have yet to be realized. At this point, of course, this is all conjecture. However, keep in mind that the stock market (and all other markets) are forward looking. The market has begun to price in the possibility that a tax reform will occur soon. As the probability of a tax cut increases, the market will bake it into it’s price (positive or negative). I believe it is more likely than not that these tax cuts (in some shape or form) will get pushed through.

We are here to help you if you feel that you are not positioned correctly in this marketplace. Feel free to reach out.

Schedule Meeting


Free Subscription

Learn how you can capitalize on the economy’s changing tides with a pragmatic approach to planning and investing. Get a free bi-weekly email with expert insights from Bull Oak’s wealth management team.