In the wake of a failed attempt to repeal and replace the Affordable Care Act Republicans are faced with the daunting task of income tax reform. The tax plan championed by House Speaker Paul Ryan calls for a reduction in the corporate tax rate to 20% from 35%. Republican leadership chose to focus on health care first so that the government savings could be spent on income tax cuts.
According to the Wall Street Journal, “the failed health bill would have made tax reform easier because it created budgetary offsets that made it easier to cut corporate taxes without adding to the deficit.” Without the estimated $1 trillion in savings, congress will need to find ways to raise revenue (possible border adjustment tax, closing of loopholes etc..) or they will have to scale back the size of the tax cuts they are planning.
Any tax cuts that do not balance the budget will require 60 votes from the US senate. Because republicans only control 52 seats, they likely will pass a more modest tax cut than originally planned.
Why does this matter to investors?
According to Robert Barro, professor of Economics at Harvard, if tax rates are lowered on average “…by 2 percentage points, I estimate that the boost to real growth in gross domestic product would be about 0.5% a year for the next two years.” Higher GDP, combined with higher after tax profits from a lowering of corporate tax rates, should result in higher stock prices.
Because the stock market has been anticipating tax reform and has been bidding up stock prices in preparation for this law, there is some risk to the downside if it doesn’t pass. Moreover, some believe that the failure to repeal and replace the ACA has weakened the President’s ability to get tax reform and possibly put Speaker Ryan’s job in danger. We can all look forward to more high drama on Capitol Hill.