The U.S. tax bill signed into law in December will have a limited effect on the U.S. economy, as companies are unlikely to spend their tax savings on growth initiatives while the tax cut for the wealthy will not trickle down.
That’s according to Moody’s Investors Service in a FAQ on the credit impact of the tax bill published Thursday, which warns of a number of negative consequences for federal debt, local governments, utilities and homeowners.
“We do not expect a meaningful boost to business investment because U.S. nonfinancial companies will likely prioritize share buybacks, M&A and paying down existing debt,” said Moody’s analysts led by Rebecca Karnovitz. “Much of the tax cut for individuals will go to high earners, who are less likely to spend it on current consumption.”
More than three-quarters of the $1.1 trillion in individual tax cuts will go to people who earn more than $200,000 a year in taxable income, who constitute only about 5% of all taxpayers, said Karnovitz.
The tax bill will significantly reduce the tax intake of the federal government in the next 10 years in the scope of 1% of GDP on average, Moody’s estimates.
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“As a result of the legislation, we expect deficits to widen faster than under our pre-passage baseline, resulting in faster accumulation of federal debt, a component of general government debt,” said Karnovitz.
Wider deficits and higher borrowing needs will come as the Federal Reserve moves to normalize interest rates after the long period of ultralow rates that followed the financial crisis of 2008 and the so-called Great Recession that followed it. “This will increase the effective cost of debt for the government faster than we previously expected, accelerating deterioration in debt affordability,” said Karnovitz.
At the levels of state and local government, it will have the effect of increasing political resistance to tax increases as taxpayers lose the state and local tax deduction, known as SALT. That means state and local governments in higher-tax areas will struggle to pay for services.
Taxpayers losing the SALT deduction will likely reduce their discretionary spending, shrinking sales-tax revenue, which is an important component of state revenue, accounting for 40% on average, according to the National Association of State Budget Officers.
Home prices will likely be hurt, too, as the lower cap on the mortgage-interest deduction reduces the tax incentive for home ownership at the higher end of the housing market.
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“Some local markets could face meaningfully slower gains or even modest declines in values, a negative for mortgage performance,” said the analyst.
For utilities, meanwhile, the lower tax rate means they will receive less money from customers, while the loss of bonus depreciation will reduce tax deferrals. “We expect that most utilities will attempt to offset negative financial implications of the tax bill through regulatory channels or through changes in corporate financial policies,” said the report.
For companies, the bill will be credit-positive, if they use cash savings to reduce debt or make disciplined acquisitions, said Karnovitz. If they aggressively increase shareholder rewards, it would be credit-negative. If they opt to hold a lot of cash on their balance sheets, it could be either.
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High-yield-debt issuers that now face new limits on interest deductibility may assume less leverage, although with valuations currently high and a lot of private-equity capital available, they are not expected to drastically change their financial policies.
For most issuers, the current rule that they cannot deduct interest expense in excess of 30% of EBITDA is unlikely to change decision making.
“When the metric converts to 30% of EBIT, however, many more companies will have to reconsider their capital structures. This change is expected in 2022, so companies will have to incorporate it into their refinancing plans as well as new leveraged buyouts,” said the analyst.
Private-equity financing overall, however, will be more challenging.
“Leverage is more expensive, and there are new limitations on net operating loss carry-forwards, which are frequently associated with leveraged buyouts,” said Karnovitz. “Some sponsors may consider using preferred equity instead.”
Moody’s analysis is so far borne out by data. Since the bill was signed, there have been more than $33 billion of stock-buyback announcements, according to TrimTabs, a trend expected to accelerate as the fourth-quarter earnings season gathers steam. Many companies have increased dividends, or promised to do so. On Thursday alone, Northrop Grumman NOC, +3.25% said it was raising its quarterly payout by 10%, while 3M Co. MMM, +2.48% raised its by 16%.
Companies have also made a series of announcements of bonus payments or wage increases, which the administration of President Donald Trump has been keen to trumpet as a victory for its agenda.
But as MarketWatch’s Steve Goldstein noted, many of these are one-time measures, and companies have been less that forthcoming about their spending and wage plans before passage of the bill.
National Economic Council Director Gary Cohn said there is a 100% correlation between the tax policy and what companies are announcing, now that they feel “more comfortable about the economic position they’re in.”
But his former employer, Goldman Sachs GS, -0.33% , seems less impressed.
“In practice, we expect no significant short-term effect of tax reform on average hourly earnings — as it excludes irregular bonuses — and only a marginal boost to the employment cost index — as irregular bonuses are smoothed out,” said a recent note by Goldman Sachs economist Daan Struyven.
The S&P 500 SPX, +1.18% has gained 6% so far in 2018, while the Dow Jones Industrial Average DJIA, +0.85% has tacked on almost 7%.
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