Stimulus and Response
In college, I had a professor who often ran late and even missed several classes outright. When he actually bothered to show up for his lectures, they usually lacked intellectual rigor. And he kept his office hours at a nearby pub.
Nevertheless, he coined one of my favorite catchphrases about American politics: “Power accrues to the presidency.”
In fact, he uttered this insight at least several times during each lecture, almost like a character delivering his signature line on your favorite sitcom.
But while the expansion of executive power has occurred with each successive administration, the increasingly imperial presidency is hardly equivalent to being a king.
Despite the flurry of executive orders and sweeping federal regulations, Congress is where a president’s agenda lives or dies, while the Supreme Court remains an important check on both.
That remains true even when all three branches of government are dominated by one party. Although a president can use his bully pulpit to compel members of his own party to fall in line, there will still be negotiations and compromises between the legislative and executive branches, especially since the president-elect is more of a populist than a party loyalist.
Some Republicans in the House leadership, for instance, were notably skeptical of Trump’s candidacy. That suggests that there will still be a competition of ideas between legislators, who ultimately hold the power of the purse, and the next president.
Even so, the market has been acting as if we just elected a king who can rule by decree. Instead, we suspect that some of the changes that have been proposed will take time to implement.
And it remains to be seen which of Trump’s numerous off-the-cuff proposals will become actual priorities. After all, like all other forms of capital, political capital is ultimately finite. And sometimes events can overtake policymaking.
The Kindest Cut
But Trump has made one policy proposal that seems among the most likely to be implemented: cutting the corporate tax rate. That’s because this policy also happens to be one of the priorities of House Speaker Paul Ryan.
The U.S. has one of the highest statutory corporate income tax rates in the world. Of course, there’s some debate about the difference between the statutory rate, which maxes out at 35%, and the effective tax rate, which is generally much lower.
Even so, allowing businesses to keep more of the income they’ve generated could be a very effective form of stimulus—perhaps even among the more democratic forms of fiscal stimulus, short of simply throwing money from a helicopter.
From a macroeconomic standpoint, in fact, it could be just what we’ve needed. While the economy may be gaining traction, we think it’s still too soon for central bankers to declare victory in their stealth war against deflation.
Even though the Federal Reserve is nominally in rate-hiking mode, the benchmark federal funds rate is still hovering at an effective rate of just 0.41%. If the economy were to suddenly take a turn for the worse, the central bank doesn’t have all that much scope left to keep things from spiraling out of control.
In fact, one of the chief complaints of central bankers—both in the U.S. and around the world—is that there’s a limit to what even extraordinary monetary easing can achieve in the absence of effective fiscal stimulus. We’ve certainly witnessed that in our own country.
From Macro to Micro
Now, getting back to a more micro level, a cut to the corporate tax rate could partially or fully offset some of the headwinds certain sectors might experience in other areas.
Utilities, for instance, sold off hard after the election due to a couple of factors: 1) speculation that Trump’s policies would boost inflation, thereby making fixed-income securities competitive with dividend stocks sooner rather than later; and 2) the expectation that the Clean Power Plan is finally dead—utilities have been shrewdly using environmental mandates as a source of earnings growth amid weak electricity demand.
We think the inflation trade is overdone, and that utilities will continue to have earnings-growth opportunities from state-level environmental mandates, which have largely driven their push toward cleaner energy anyway.
And such maneuvering seems to have completely discounted the potential benefits of a corporate tax cut.
Thanks to my trusty Bloomberg terminal, I was able to pull data for the effective tax rate across the electric utilities sector. The 44 U.S. electric utilities had an average effective tax rate of 30.8% in their most recent fiscal year.
Now that number probably includes state-level taxes, but it shows just how significant the tax burden is for these companies.
Indeed, the average income-tax expense reported among U.S. electric utilities in their most recent fiscal year was $295.3 million. And the average income-tax expense among the four utility giants, the ones that most income investors hold in their portfolios, was $1.2 billion.
Trump has proposed cutting the business tax to 15% from 35%, while Ryan has proposed lowering it to 20%. Either way, that would allow some of our favorite companies to retain more profits to deploy as they see fit.
While utilities have hardly been hurting for capital in this low-interest rate environment, it’s always good to have more of it, especially when there’s at least some policy uncertainty.
Perhaps most immediately, it could be put to constructive ends, such as paring debt.
Cheap capital has fueled a sector spending spree that’s boosted leverage well beyond historical norms. Net debt to EBITDA (earnings before interest, taxation, depreciation and amortization) averages 4.1x across the sector, while debt to equity is at 123.4%.
Of course, the sector has also been in consolidation mode, and tax savings could reduce the need to issue equity and debt when pursuing mergers and acquisitions.
Or utilities could choose to return more cash to shareholders via dividend growth, a possibility that should warm the heart of any income investor.
At the very least, a corporate tax cut means more money will flow to the bottom line.
Regardless, utilities will be able to retain more of their own money. Assuming they’re generally effective stewards of capital, that should ultimately be a good thing for shareholder value.