House, Senate Republicans Reach Tax Deal: Here Are The Initial Details

One day after we reported that "Congressional Republicans reached a tentative tax agreement", the news of which sparked another risk surge into the close of trading, moments ago we got the second tax deal in 24 hours - if only for algo consumption - when the AP reported that House and Senate GOP leaders have reached a "tentative deal" on tax overhaul "in principle."

The AP quoted a "person familiar with the conversations who asked not to be named because the discussions are private" and who is certainly long stocks, as the replica headline was enough to send the S&P to new all time highs. 

The agreement "in principle" paves the way for final votes next week to slash taxes for businesses and give most people tax cuts starting next year. Top GOP aides say the deal was reached on Wednesday. They spoke on condition of anonymity because they were not authorized to speak publicly about the deal. Details still need to be drafted and assessed by congressional scorekeepers but the final House-Senate compromise is on track to be unveiled this week. 

The details, virtually identical to what we reported yesterday: the top individual tax rate would be lowered to 37% as and set the corporate tax rate at 21%, slightly higher than the 20% initially favored by President Trump. The mortgage interest deduction would be capped at $750,000, a mid-point compromise between the Senate and House bills.

The deduction for pass-through companies will be set at 20 percent, somewhat lower than the 23 percent included in the Senate-passed bill. That will be offset by lowering the top individual income rate to 37%. It is now 39.6%.

* * *

Still, lawmakers will need to get a cost analysis of their agreement, so it’s not yet definite, "the person" said, who clearly gets around and was this time quoted by Bloomberg.

And since lawmakers still need to get a cost analysis of their agreement, not only is today"s "tentative deal" not yet definite, but it will almost surely be unwound when someone actually brings a calculator into the room.

Curiously, after jumping higher, stocks have since faded the kneejerk reaction higher, perhaps realizing that the more fiscal stimulus that is injected, the more tightening the Fed will have to unleash in the coming months as inflation become red hot.

Corporate Tax Cuts: "The Seen & The Unseen"

Authored by 720Global"s Michael Lebowitz via RealInvestmentAdvice.com,

Since Donald Trump was elected President, the S&P 500 has rallied over 21% or nearly 500 points. In our opinion, a good portion of the gain is attributable to his promise, as well as congressional efforts, to reform the tax code. In particular, the proposed sharp reduction in the corporate tax rate has the equity market’s attention. At first blush, the simple logic driving equity investors appears reasonable.

Appearances, however, can be deceiving, and history is littered with failed investors that banked on a faulty thesis. As such, instead of tripping head first into that same category, we decided to assume nothing and look at the proposed reduction in the corporate tax rate and historical data to better understand how the legislation might affect the economy and corporate earnings.

Corporate Tax Rates

The graph below highlights the statutory and effective corporate tax rates since 1947.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

The statutory tax rate is the legally mandated rate at which corporate profits are taxed. As shown above, the rate has been consistent over the last 75 years except for one significant change as a result of the Tax Reform Act of 1986.

The effective corporate tax rate is the actual tax rate companies’ pay. One can think of the statutory rate as similar to the MSRP sticker price on a new car. It provides guidance on cost but consumers always pay something less. The effective tax rate, like the “discounted” price one pays for a car, is the actual percentage of profits that corporations remitted to the government. This rate is calculated by dividing a company’s tax payments by their pre-tax profit. Deductions of all sorts reduce the pre-tax profit, thus creating a difference between the statutory and effective tax base and therefore the amount paid. For purposes of this article, we aggregate corporate tax receipts and corporate profits to calculate an effective rate for all corporations.

From 1947 to 1986 the statutory corporate tax rate was 49% and the effective tax rate averaged 36.4% for a difference of 12.6%. From 1987 to present, after the statutory tax rate was reduced to 39%, the effective rate has averaged 28.1%, 10.9% lower than the statutory rate.

Based on this simple analysis thus far, it is easy to understand why equity investors are giddy over a sizeable reduction in the corporate tax rate. If the statutory rate is reduced to 20% as proposed, and the effective rate remains 10% lower, the amount of money corporations pay in taxes will be reduced sharply. Based solely on this assumption, corporate after-tax profits, in year one alone, should increase by almost $200 billion while federal corporate tax receipts will be reduced by the same amount. Such a boost in corporate earnings would increase the forecasted internal rate of return (IRR) on the S&P 500 by approximately .90%.  Holding everything else constant this equates to a price increase of 285 points for the S&P 500 or an 11% gain from today’s level. It is impossible to assess how much of the gain since the election is due to tax reform expectations and how much is due to other factors, but we wager a good portion of it has been based on the promise of tax reform.

History

While the math and logic above seem sound, we can turn to historical data to understand the relationship between taxes and economic growth and profits. In doing this, we can better forecast the actual effects that lower corporate taxes might have on economic growth and corporate profits.

The graph below compares the effective corporate tax rate to the running three-year average GDP growth rate. The dotted trend lines smooth the data to allow for a clearer comparison.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

As is clearly observable, GDP has trended lower at a very similar pace as the effective corporate tax rate. The graph below puts the data in a scatter plot format to evaluate the statistical relationship between corporate tax rates and economic growth rates.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

The R² shown above (.3552), a statistical measure of correlation, is far from perfect, but there is a reason to believe that lower effective tax rates may partially explain the weakening trend in GDP growth.  Based on statistical regression, every 1% decrease in the effective tax rate should diminish GDP growth by 0.12%. 

The President, his economic team, and lawmakers are selling the tax bill with claims that a reduction in corporate taxes will boost economic growth. Based on data from the last 75 years, that has never been the case. In fact, the average annualized GDP growth rate in the five years before the major statutory tax reduction in 1986 was 3.90%. In the five years following the tax cut, the average annualized growth was reduced by more than half to 1.93%.

Next, we show a scatter plot comparing effective tax rates to corporate profits.

Data Courtesy: St. Louis Federal Reserve (FRED)/ BEA (NIPA tables)

As measured by a R² of .051, the graph above shows that over the last 75 years, there has been no measurable relationship between effective corporate tax rates and corporate profit growth.

Who Pays

The historical evidence above tells a different story than the bill of goods being sold to citizens and investors.

 Corporate tax rates are positively correlated with economic growth which means that lower corporate tax rates equate to slower economic growth. Further, there is strong evidence that corporate profits are largely unaffected by tax rates.

Investors buying based on the benefits of the tax proposal appear shortsighted. They value the benefits of corporate tax cuts, but they are grossly negligent in recognizing how the tax cuts will be funded.  

The tax bill, as it is currently proposed, will increase the deficit by $1.5 trillion over ten years. As such, the government will borrow an additional $1.5 trillion on top of current projections of approximately $1 trillion per year.

When the government borrows money to fund a fiscal deficit they effectively crowd out investment that could have funded the real economy. Said differently, the money required to fund the government’s deficit cannot be invested in the pursuit of innovation, improving workers skills, or other investments that pay economic dividends in the future. As we have discussed on numerous occasions, productivity growth drives economic growth over the longer term. Therefore, a lack productivity growth slows economic growth and ultimately weighs on corporate earnings.

A second consideration is that the long-term trend lower in the effective corporate tax has also been funded in part with personal tax receipts. In 1947, total personal taxes receipts were about twice that of corporate tax receipts. Currently, they are about four times larger. The current tax reform bill continues this trend as individuals in aggregate will pay more in taxes.

As personal taxes increase, consumers who account for approximately 70% of economic activity, have less money to spend.

Summary

As is often the case in economics and investing, there is a “seen” and an “unseen.” The “seen” is widely visible and, right or wrong, generally represents a consensus agreement about reality. The “unseen,” while equally important, largely goes under-appreciated. In time, it is the “unseen” that will affect economic growth rates and corporate earnings. It is the “unseen” that investors must grasp if they are to be successful. In this case, the “unseen” is the massive federal deficit. Its burden on the economy prevents traditional forms of stimulus from having their desired effects.

Given the historical evidence regarding the implications of corporate tax cuts, we are left questioning the so-called “Trump bump.” We would argue that a market rally based on that premise is incoherent, and the market should be discounting prices and valuations due to the tax cuts not inflating them.

Just 10 Companies Account For 33% Of All Market Gains Since Trump"s Election

Yesterday we laid out the reasons why French bank SocGen unveiled a surprisingly contrarian forecast, according to which the S&P would tumble from its current level over 2,600 to 2,000 in 2018, representing a more than 20% bear market drop...

... the drop catalyzed by rising interest rates pressuring P/E multiples, a late cycle economy nearing recession, equities trading at record valuations, and with everyone short vol begging for a vol short squeeze. Not surprisingly, SocGen"s unspoken advice was to get out now.

And while many of the negative factors highlighted by SocGen had already been discussed here in the past, there were two we warned to bring attention to: the market"s multiple expansion since Trump"s election, and the narrow leadership in the S&P.

As we noted yesterday, contrary to the widely accepted narrative, while the S&P 500 has risen 24% since Trump"s election, only half of this performance has been driven by earnings growth; the other half is from P/E expansion. But why would P/Es rise at a time when the Fed is tightening? As SocGen speculated, assuming that analysts have not factored tax reform into their earnings forecasts, tax reform expectations have been the driver of P/E expansion. There is a problem with this: while the S&P 500 index tax rate is currently 26.6%, assuming that US companies generate 43% of their profits abroad (here) and pay 35% of their US profits on taxes (i.e. with no loopholes for US profits), the average tax rate outside the US would be 15.5%. A decrease in the US tax from 35% to 20% as planned by Trump’s tax reform would thus theoretically boost earnings by 8.5%. The 12-month forward P/E has risen 12% over the last 12 months. In other words, roughly 150% of Trump"s tax cuts have been priced in!

However, another especially interesting observations goes to the leadership of this 24% rally since Trump"s election, which - while hardly a surprise - was largely driven by a handfull of companies, or ten to be precise.

As SocGen calculates, just 10 contributors of the S&P 500’s bull run have accounted for 33% of the S&P 500 performance. Tying to the above, the bank also points out that all of the companies listed below have seen their P/Es expand over the last 12  months, in some cases - like Nvidia, WalMart, Boeing and Amazon - dramatically. In fact, only three companies (Apple and the two banks) have 12-month P/Es that are below the market average (18x). Lastly, keep in mind that except Amazon, all of the companies already pay a  corporate tax rate below the current US federal tax rate (35%), and five companies even pay a tax rate that is below the 20% rate targeted by Trump’s tax reform.

As we asked two days ago when we showed that the bulk of hedge funds gains in 2017 have come from holding this same handful of companies, what happens to hedge fund performance - and the S&P 500 - when, for whatever reason, the tide turns and the winners are the first to be sold?

Diabetes is on the Rise Among Tweens and Teens

Type 2 diabetes was once considered an old person’s disease; but as more Americans became obese, younger adults started developing the condition. Now type 2 diabetes is striking a growing number of kids. Data from the CDC show that about 17% of kids and teens in the U.S. are now considered obese, and a new study indicates that there has been a corresponding increase in childhood cases of type 2 diabetes. [1]

In the past, type 2 diabetes was referred to as adult-onset diabetes because the condition would take years to develop. These days, even toddlers are being diagnosed with the disease.

Scientists recently reviewed data on 10- to 19-year-olds in primarily five states – California, Colorado, Ohio, South Carolina, and Washington – and determined that 12.5 of every 100,000 of them had full-blown type 2 diabetes in 2011 and 2012. In 2002 and 2003, just 9 out of every 100,000 kids had the disease. [1]

Read: Number of Children with Diabetes Jumps 14% Between 2000-2008

After accounting for age, gender, race, and ethnicity, the authors of the study, published in the New England Journal of Medicine, found that the incidence of type 2 diabetes in this age group rose by 4.8% during the study period. That means that about 1,500 more kids and teens were diagnosed with type 2 diabetes each year at the end of the study period compared with the beginning. [1]

Gaps in Gender and Ethnicity

The rate of new diagnosed cases of type 2 diabetes rose most sharply in this age group among Native Americans (8.9%), Asian Americans/Pacific Islanders (8.5%), and non-Hispanic blacks (6.3%). [2]

Among Hispanics ages 10 to 19, the rate of new diagnosed cases increased 3.1%. The smallest increase was seen in whites (0.6%).

The rate of new diagnosed cases of type 2 diabetes increased much more significantly in females (6.2%) than in males (3.7%).

Source: Los Angeles Times

Barbara Linder, M.D., Ph.D., senior advisor for childhood diabetes research at NIH’s National Institute of Diabetes and Digestive and Kidney Diseases, said:

“These findings lead to many more questions. The differences among racial and ethnic groups and between genders raise many questions. We need to understand why the increase in rates of diabetes development varies so greatly and is so concentrated in specific racial and ethnic groups.” [2]

Tweens and Teens Affected Equally

In 2003, slightly more teens than tweens had type 2 diabetes, with 10 cases of type 2 diabetes per 100,000 teens (ages 15-19) compared with 8 cases per 100,000 among tweens (ages 10-14). However, by 2012, there were 12.9 cases per 100,000 in teens and 12.1 per 100,000 among tweens. [1]

Years of Life Lost

The complications of type 2 diabetes are many, but generally include heart and blood vessel disease; nerve damage (neuropathy); kidney damage, sometimes leading to the need for dialysis or transplant; eye damage; foot damage, often leading to infection and amputation; hearing loss; skin conditions; and possibly Alzheimer’s disease. [3]

The longer diabetes goes untreated, the more damage it does to the body. This is especially concerning among young people, whose lives may be shortened.

The number of years people lived with diabetes-related disabilities rose globally by nearly 33% between 2005 and 2015, according to a report published in 2016 in The Lancet. Conversely, the number of years of life lost to type 2 diabetes increased more than 25%. [1]

In other words, doctors are doing a better job of treating diabetes and diabetes-related conditions, yet “the overall adverse effect of diabetes on public health is actually increasing,” according to an editorial accompanying the study.

Sources:

[1] Los Angeles Times

[2] National Institutes of Health

[3] Mayo Clinic

Los Angeles Times

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About Julie Fidler:
	Julie Fidler is a freelance writer, legal blogger, and the author of Adventures in Holy Matrimony: For Better or the Absolute Worst. She lives in Pennsylvania with her husband and two ridiculously spoiled cats. She occasionally pontificates on her blog.

Goldman: "The Boost From Lower Taxes Will Now Be Smaller, Occur Later Than Expected"

With both JPM and Goldman having warned for months that the market is far too sanguine about the implementation (and effectiveness) of Trump"s proposed domestic fiscal policies, Friday"s events were a rude awakening for some, and framed how contentious the passage of any stimulus measures by the new president - one who as the WSJ writes this morning is realizing he misses a governing coalition - will be. And while coming to grips with the qualitative aspects of Trump"s failure to cobble together a deal was Friday"s business, the key question now deals with the quantitative aspects of what happens next, starting with Trump"s tax reform which as the president himself said will be his immediate next focus as Obamacare repeal is left indefinitely on the back burner.

Here are some thoughts from Goldman"s David Kostin.

Investors have begun to appreciate that the boost to S&P 500 earnings from corporate tax reform will likely be delayed until at least 2018.

* * *

The boost to S&P 500 earnings from a lower corporate tax rate is likely to be smaller and to occur later than investors originally expected.

The House Republican blueprint proposes a reduction in the statutory federal corporate tax rate to 20% from the current 35%. We estimate that a 5 pp reduction in the effective tax rate would boost ROE by 100 bp and lift S&P 500 EPS by about 6%.

However, our Washington, D.C. economist expects the tax rate will be cut less than proposed to roughly 25%. Investors have also reduced expectations for the timing and size of tax reform. After outperforming the S&P 500 by 520 bp post-election, our basket of stocks with the highest effective tax rates has given back all of its post-election gains in the last three months (see Exhibit 1).

The flipside, however, is that according to Goldman, the market appears to have now largely priced this in, and as a result over the past month, companies in the "high-tax rate basket" have given up all their post election gains and then some. In fact, if anything, there is some modest scope for upside surprise should Trump fail to disappoint on his next key legislative item.

Uncertain In 2017? Analysts Expect “Silver and Gold Rally Under Trump”

This article was written by Steven Maxwell and originally published at Activist Post.

Editor’s Comment: Can they hold back gold and silver prices forever, despite obvious manipulations of the price? Maybe. It remains to be seen how much brute force and ridiculous propaganda can hold back the pressure piling on the fiat currency system, and an economy that is skewed to produce cream for the 1%.

More likely though, at some point, they won’t be able to hold gold and silver back any longer. Most analysts peg the real value of gold at over $5,000, though the market doesn’t come anywhere close to that value, with banksters trading on futures and messing with the price point. During a crisis, or a long-standing emergency, and one where goods and essential services are lacking or no longer available, the true value of gold and silver as lasting commodities will once again shine through – it could be used for barter, debt payoffs or collateral for barter of smaller or perishable items including food.

Regardless of all the funny business with the dollar, the propping up of the stock market and the push to move more and more onto the grid, precious metals can hold their own when allowed to do so.

Will Silver and Gold Rally in 2017 Under Trump?

by Steven Maxwell

Unstable economic conditions and a Trump presidency may cause a rally in precious metals.

Trump’s protectionist policies and his support for auditing the Federal Reserve could make silver and gold an attractive hedge in 2017. Couple that with a bubble economy that has many bloated sectors ready to be pricked, sending capital flooding out of paper assets into safer places.

Under Obama, silver hit a low of $9.46/ounce on November 6th 2008, a mere two days after Obama was elected as the 44th US president. After an epic real estate and stock market meltdown led to an unprecedented Fed bailout, a rally for paper assets and metals ensued.  Silver hit highs above $50/ounce in April of 2011.  While Obama readies his exit from the White House, the stock market continues to ride the stimulus bubble, but silver has substantially retreated to near its lowest price under his Administration – $16.80/ounce.

Source: Bullionvault.com

Although silver may seem to be a cheap and boring investment compared to the prospect of 20,000 Dow, had you bought it during those early days following Obama’s election, your investment would have still gained about 70 percent with a future that appears to be even shinier.

The price in precious metals swung a bit on election night – up when a Hillary win was expected, down after it was clear Trump would be victorious. Apparently a lot of people were rage dialing their brokers late into election night resulting a near five percent plunge in the Dow Jones in after-hours trading.

2016 Election Night Chart of Dow Jones: CNBC

This illustrates the fact that there can be emotional volatility during any time of transition and a subsequent rush to safety. On election night people ran to cash for safety. Yet, ongoing currency wars and potential trade wars with Trump’s proposed tariffs could make precious metals an important hedge.  Remember that other countries also buy silver and gold when currencies become unstable.

Those with physical metals or gold and silver in IRA could also benefit from Trump’s $1 trillion infrastructure plan, both because it will require printing money (inflation) and because the new construction will require more fabrication metals than a free market would normally demand.

One recent development that could also lead to potentially higher prices is the Deutsche Bank settlement last year over precious metals price rigging and their testimony about other participating banks. This punishment might create an atmosphere of more honest pricing going forward in 2017 and beyond as the market adjusts to its new freedom after the fallout.

Recall according to Bloomberg:

Deutsche Bank AG has reached settlements in lawsuits over allegations it manipulated gold and silver prices, lawyers for traders of the commodities said in court filings.

Attorneys for futures contract traders in two private lawsuits said in letters filed Wednesday and Thursday in Manhattan federal court that the bank has executed term sheets and is negotiating final details for the accords.

….

“In addition to valuable monetary consideration to be paid into a settlement fund, the term sheet also provides for other valuable consideration such as provisions requiring Deutsche Bank’s cooperation in pursuing claims against the remaining defendants,” attorneys Daniel Brockett and Merrill Davidoff said in their letter Thursday in the gold-fixing lawsuit.

Silver and gold futures traders sued groups of banks in 2014 alleging they rigged prices for the precious metals and their derivatives. Silver traders brought claims against Deutsche Bank, HSBC Holdings Plc, Bank of Nova Scotia and UBS AG. Gold traders additionally sued Barclays Plc and Societe Generale SA.

If an atmosphere of more transparency should take hold under a Trump presidency and other governments around the world, it’s reasonable to assume that precious metals will begin a steadier trajectory upward, rather than some of the severe volatility they have been subjected to. Once proper pricing is firmly established, mining companies will then be able to show their investors steadier returns, heralding a potential surge across the board.

A final economic consideration that continues to highlight physical silver as a strong asset is a year-over-year shortage, with production decreasing on a global scale. Once again, this reality has not been fully reflected in its current price. If all factors remain relatively constant, silver and gold will likely climb in value in 2017.

However, if any of the major financial bubbles burst, it could depress global demand for all commodities in the short term.  So it’s best to stay diversified and adaptable.

This article was written by Steven Maxwell and originally published at Activist Post.

Here Are The Winners And Losers From Trump's "Border Tax Adjustment"

In late December, we explained why of all Trump economic proposals , the "border tax adjustment", while most controversial, could have the biggest impact on US assets.

As a quick refresher, the proposal would tax US imports at the corporate income tax rate, while exempting income earned from exports from any taxation. The reform would closely mirror tax border adjustments in economies with consumption-based VAT tax systems. If enacted, Deutsche Bank predicted that the plan would be especially bullish for the US dollar, sending it higher by as much as 15%. What’s more, it would have a transformational impact on the US trade relationship with the rest of the world. Consider the below:

• A “border tax adjustment” would, roughly speaking, be equivalent to a 15% one-off devaluation of the dollar. Imports would be 20% more expensive, because corporates would have to pay the new 20% corporate tax rate on their value. Exports would be roughly 12% “cheaper”, because for every $33 of earnings earned from $100 of exports (we use the 33% gross margin of the S&P), there would be a 12% tax cost ($33 earnings*35% current tax rate) that would no longer be imposed on corporates. Taking the average impact on the prices of exports and imports is equivalent to a 15% drop in the dollar.


• A border tax adjustment would be very inflationary. The price of exports doesn’t affect the US consumption basket so would have no impact on CPI. However, the cost of imports would go up by 20%, which based on a simple relationship between import PPI and US inflation would be equivalent to a 5% rise in the CPI. Corporates may of course choose to absorb part of the rise in import costs in their profit margins. But either way, the order of magnitude is large.


• A border tax adjustment would be very positive for the US trade balance. Similarly to the dollar calculations, a border tax adjustment would be equivalent to an across the board import tariff of 20% and an export subsidy of 12%. Keeping all else constant and applying standard trade elasticity impact parameters to an average of the two estimates results in a more than 2% drop in the trade deficit equivalent to more than 400bn USD, or equivalently, an almost complete closing of the US trade deficit.

In other words, should the "border tax proposal" pass, it would not only send inflation soaring, while eliminating the US trade deficit - a long-time pet peeve of Trump  - it would also be the trade-equivalent of a 15% USD devaluation, even as it leads to an offsetting surge in the actual value of the dollar.

To be sure, the "should it pass" part is a significant wildcard.  As Goldman wrote in a note yesterday, explaining "what policy changes is the equity market expecting", Goldman said that "on the tax side, the equity market appears to expect corporate tax cuts, but the evidence that a switch to a border-adjusted tax is even partially priced is only mixed."

A reason for that within the GOP ranks, a fight has emerged - funded by powerful Koch interests - against the border tax proposal, as it would cripple non-export driven businesses such as importers, apparel makers, big retailers, and various core Koch businesses as described recently by the FT.

So while the passage of the controversial Border Tax Adjustment is far from assured, overnight Credit Suisse released an analysis which analyzed the various winner and losers from the array of proposed Trump Tax Reforms, among which companies impacted by the Border Adjustment.

While the Swiss bank hedges early, noting that it is still "too early to determine winners/losers as new information is surfacing daily…and the legislative process needs to run its course this year" and that "reforms (complexity) could impact the effective tax rate, cash taxes, and/or possibly COGS (border adjustments)", it nonetheless does quantify who the various winners and losers from the BTA would be, which it frams as follows:

Here is Credit Suisse" answer:

Potential Winners

• Companies with a majority of their input costs contained within the U.S.
  
  • Potentially lower tax rate of 20% on sales and full deduction for input costs, potential examples: Health Care Service Providers, U.S. Cable/Telecom, Oil Refiners that source from the U.S., U.S. based manufacturer.
  
  


• U.S. Exporters: as export revenues are not subject to U.S. tax.

Potential Losers

• Products, services, and intangibles imported into the U.S. will be subject to the border adjustment.


• Bottom up exercise to determine global supply chain (Automakers, Oil and Gas, to Retailers can be impacted).


• U.S. Multinationals that have relied on aggressive tax planning to shift earning overseas.


• Financial Statement effects: Unknown at this point but could result in a higher effective tax rate or COGS, lowering net income in particular for US companies that are net importers.

CS then looks at which specific companies could find border adjustments a potential positive, among which:

3M (MMM) Analyst Meeting – 2017 Outlook: There"s three points on the border adjustment portion.

• One is, yes, we are a net exporter, so that clearly plays to our favor …


• Second is commodities …There is not a materially amount of commodities that we are bringing over the border into the U.S. Much of how we manufacture is about often wanting to have our commodity source locally.


• Third point is our own strategy around intellectual property. 3M"s intellectual property is owned in the United States, and then under the current discussions around border adjustment that also would be a benefit for 3M. But as you started out saying, it"s early.

General Electric (GE) Investor Meeting – December, 2017: We"re a big exporter and not a big importer.

• Tax reform…based on everything that the new Secretary of Treasury said, the President-elect has said, leader – Speaker Ryan has said, I can never dictate the puts and takes, but I think there is – if you"re a net exporter, manufacturer, stuff like that, I think there"s opportunities…It is a huge incentive and it is a – it"s accretive to the company.

And then, a potential negative:

• Michael Kors (KORS) 10K: In fiscal 2016, by dollar volume, approximately 97.2% of our products were produced in Asia and Europe….We primarily use foreign manufacturing contractors and independent third-party agents to source our finished goods.


• Nike (NKE) 10K: Virtually all of our footwear is manufactured outside of the United States by independent contract manufacturers who often operate multiple factories. In fiscal 2016, contract factories in Vietnam, China and Indonesia manufactured approximately 44%, 29% and 21% of total NIKE Brand footwear, respectively.


• Target (TGT) 10K: In addition, a large portion of our merchandise is sourced, directly or indirectly, from outside the United States, with China as our single largest source.


• Emerson (EMR): We manage businesses with manufacturing facilities worldwide, a majority of which are located outside the United States, and also source certain materials internationally.

The bank next points out that companies already “manufacturing” (at least partially) in the U.S. could be in a better position under tax reforms:

A factor here would be the domestic manufacturing deduction (DMD):

• Although subject to complex rules, the DMD provides a tax break for certain U.S. based manufacturing and production activities.


• Those activities can range from basic manufacturing to the production of software and can include products that are partially “manufactured” outside the U.S..


• Note that this benefit could go away under new U.S. tax reforms. Nevertheless it provides an indicator that companies have some U.S. based manufacturing and could be in a better position to avoid border  adjustments.

On the other hand, companies with high levels of foreign earnings and very low foreign tax rates, are at increased risk:

Profit shifting

• Having international exposure is not a risk under pending reforms and could actually be a benefit (no U.S. tax on exports, territorial system).


• However, the location (i.e. low tax country) of multinational profits will be under continued pressure by the OECD, EU, and U.S. tax Reforms.


• Companies with high levels of foreign based earnings relative to foreign sales and unusually low foreign tax rates could be at risk to global tax reforms (U.S. Border Adjustments, EU, OECD,).

Finally, here is a practical example of how BTA might work in real life: