Economists at the Royal Bank of Canada gave an optimistic take on tax reform plans unveiled in the U.S., suggesting in its current form it will boost growth and urge investors to rethink the stock markets.
"Acknowledging that some key details are still missing, a good baseline is that this tax plan could increase GDP (gross domestic product) growth by at least 0.5 percent per year," senior U.S. economists Tom Porcelli and Jacob Oubina at RBC Capital Markets, and Michael Cloherty, head of U.S. rates strategy at the firm, said in a note on Wednesday evening.
"We think the fact that tax cuts are coming at the mature stage of the cycle and not in a typical post-recession means the 'propensity to spend' could very well be higher than historically observed … Over a decade, the level of GDP could be 5 percent higher than a baseline forecast," they added.
By implementing tax cuts, the U.S. Treasury Department could be facing a "static cost around the $2.0 trillion zone," they said. The Treasury could be forced to borrow more, potentially increasing the deficit at a time of already high borrowing and rising interest rates, they added. RBC also predicts that the Federal Reserve could be forced to rate hikes at a quicker pace due to the "firmer GDP, lower unemployment, firmer inflation."
RBC estimates that slashing taxes could add an average $10.50 to an S&P 500 company's earnings per share (EPS) over one year. Earnings per share is an important metric used by stock traders to indicate a company's profitability. Thus adding an additional 200 points to the S&P.
"This is a direct flow-through to the bottom line. We'd also have to consider any impact from increased buybacks from not only a lower corporate rate but from repatriation flows. Moreover, we'd have to consider the positive knock-ons to topline growth from a firmer GDP profile on the back of the individual tax reductions," they said. Buybacks occur when firms purchase their own shares, reducing the proportion in the hands of investors. Like dividend payments, buybacks offer a way to return cash to shareholders and usually see a company's stock push higher as shares get scarcer.