Corporate tax cuts are likely to have a positive effect on economic growth, and could buoy the equity markets by raising after-tax earnings and corporate investment.
Republicans agreed in principal in late December on a final tax bill that would cut taxes for businesses and individuals. It’s worth noting that with the corporate tax rate at 26%, lowering it to 20% or 22% in 2018 or 2019 is not going to transform the economy. Still, an estimated 60% of companies may benefit from a tax cut. Therefore, the tax reform could create some upward momentum in growth.
At the margin, corporate tax reforms could buoy the equity markets by raising after-tax earnings and corporate investment. Investment projects that are currently not viable could become more possible with a lower tax rate. Of course, the cost of capital is already low, but while the effect may be small, we should see a measurable positive impact on growth.
The household tax cuts will have little impact on consumption because they are, in net terms, very small and geared toward high-income households. But the rally in equity markets creates a wealth effect, and this will boost consumption growth in 2018. The labor market is key to household income and spending, and it continues to improve, albeit at a slower pace. Consumption growth in 2018 is expected to mirror 2017 and may be a little bit stronger.
At the margin, corporate tax reforms are likely to help the equity market by raising after-tax earnings and boosting corporate investment.
Recession risk remains limited
The relentless flattening of the yield curve since September has produced some concerns that a recession is just around the corner. If the yield curve keeps moving the way it has, pretty soon it will be inverted, goes the argument, and then there’ll be a recession.
This reasoning deserves some skepticism. Recessions are infrequent, and precisely because they’re infrequent, they are hard to forecast. Different recession-forecasting models take different approaches, and while none of them is perfect, neither do any of them suggest a recession is just around the corner.
Recessions are infrequent, and precisely because they’re infrequent, they are hard to forecast.
Today, in other words, the business cycle is unlikely to cause a recession. While an external geopolitical shock from North Korea or the Middle East could precipitate a downturn, the most likely route into a recession, in our view, is inappropriate monetary tightening. An overly aggressive Fed could produce a sharp downturn in the economy. And it’s worth bearing in mind that the FOMC is losing a lot of experience with Stanley Fischer gone, and with Janet Yellen and William Dudley leaving in early 2018.