A headline item of the GOP tax bills pending in Congress is the proposed corporate tax cut to 20% from 35%. The tax cut would put an estimated $1 trillion in projected earnings back in the bank for U.S. corporations for growth and capital spending. Also in the bills is the reduction in the deductibility of interest payments, which should have ramifications for both the debt and equity markets.
Debt boom: U.S. companies have feasted on sub-4% interest rates, with more than $1.8 trillion in debt issued so far in 2017. The reduction of the interest deduction and expected higher rates could lead to less debt in the market.
Debt vs. stock: Companies' preference for debt has been seen in the rising debt-to-EBITDA ratio as cash flow hasn't kept up with debt growth. At the same time, shares outstanding have fallen.
Alignment: Taxes and interest expense have been moving in opposite directions, as more debt is issued while operating incomes have been more erratic. Expect interest expense to fall along with tax expense.
Tax trend: Tax costs have been declining with little regard to EBITDA. Deductions allow for effective rates lower than stated rates, a trend that will continue despite less flexibility.
Universe used is Russell 3000.
Sources: Bloomberg LP, Damodaran Online NYU Stern School of Business
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