In considering the prospective impact of the proposed American Jobs Act, it may be useful to distinguish between the economic meaning of investment, versus the more popular lay usage of the word. For the economist, investment is a synonym for business spending — a segment of gross domestic product that accounts for approximately 18 percent of the total measure of economic activity. Some investment pertains to new economic activity, but the vast majority of such spending meets the requirements of pre-existing business entities. These spending categories include expenditures on such things as inventories, supplies, salaries, equipment, maintenance, and business services purchased from other businesses.
The massive government spending authorized by the currently envisioned American Jobs act will undoubtedly stimulate incremental investment, irrespective of the higher corporate tax rate; and this business spending will likely be expanded further by provisions in the act designed to disincentivize companies from maintaining or expanding their overseas operations. Whether the tax code revisions will successfully arrest the overall exodus of manufacturing jobs, however, remains to be seen.
In contrast to the way economists consider investment, non-economists generally think of investments as a form of savings. For instance, buying stock is thought of an investment; but it should be realized that each buyer has a corresponding seller. While the former is investing, the latter is disinvesting. The transaction simply reflects a change of ownership; but in the aggregate, no new economic activity has transpired.
With this second orientation, a nearly universal concern is how the proposed legislation will affect the stock market. While I subscribe to the expectation that aggregate investment (in the economic sense) will likely grow, even in the face of higher corporate taxes, I’m less certain about the impact for stock market investors. All else equal, higher tax rates would reduce corporate profits, but the more rapidly growing economy (largely due to the added stimulus) would likely serve to expand aggregate pre-tax profits. For some companies, the higher pre-tax profits will more than offset the effect of a higher tax rate; for other companies, the effect of the higher tax rate will dominate. Put another way, after-tax profits will rise for some companies and fall for others.
Those of us who are indexers don’t much care about this likely structural shift, but for investors who select individual stocks, a change is coming. There’s a good chance that major infrastructure providers and affiliate concerns will come to enjoy improved profitability under the proposed legislation. We just don’t know when these higher profits will start to be realized; and we also don’t know when this effect will be reflected in stock prices.… if it hasn’t been built in already. Unfortunately, with stock picking, timing is everything.
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