UBS: "The biggest tax cut in US history" – What is the impact on equities?

Border tax adjustments have been said not to work in their current form but discussions are continuing. Overseas cash will be repatriated at a one-time tax rate, although this rate is yet to be determined. The timeline for US tax reform is still unclear. The budget neutrality of these proposals has not been outlined in detail. Secretary Mnuchin stated that the reform would pay for itself with economic growth.

Equity valuation considerations

Simplifying the US tax code and lowering the marginal tax rate to 15% will provide a cash flow uplift for many US companies. However, this uplift must not be assessed as a 35% to 15% cash flow uplift. This overstates the impact. US companies generally do not "pay" tax at the 35% marginal tax rate on pre-tax earnings. The aggregated S&P 500 effective tax rate is c.28% (UBS). Some companies with very low effective tax rates may see their tax burdens increase under a simplified tax code that taxes pre-tax earnings at 15%. Companies with material overseas cash balances will be able to repatriate cash at a, as yet undetermined, "competitive" tax rate. This should provide additional liquidity to these companies, as trapped cash is effectively released to the business. The value of this release depends on returns generated on the usage of this cash.

Do we think the marginal tax rate will be ultimately be 15%?

In our original work (see Spotlight on….Trump, tax reform and the impact on US equity prices – "The interactive model", 6 December, 2016) we hypothesised that the marginal tax rate would settle in the region of 20-25%. We still retain this view, and believe the 15% marginal tax rate will be negotiated upwards to ensure a smoother passage through Congress, thereby easing some of the financing tensions associated with such a significant tax cut. UBS tax simulation model There are still uncertainties around the final marginal tax and cash repatriation rates. Is border tax reform assigned to history? Our Tax simulation model allows investors to run potential tax reform scenarios for over 400 UBS covered US companies.