On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act of 2017 into law. Having gone into effect on January 1, 2018, the law’s provisions—most notably in business taxes—have the potential for significant change in a range of industries. The two key portions of the new tax law are analyzed below as they pertain to industry-level performance.
In addition to lowering the highest corporate tax rate from 35.0% to 21.0% and providing significant deductions available for pass through entities, the law also enables businesses to effectively and immediately deduct all investments in equipment, structures and inventories, rather than capitalizing and depreciating these investments over time. These changes are likely to have a positive impact on corporate profit and capital investment moving forward.
Corporate Profit: Winners and Losers
IBISWorld recognizes 182 US industries where corporate profits levels are deemed a key external driver of industry performance. In other words, 182 unique industries can have a meaningful portion of their growth or decline attributed to a sensitivity to corporate profits. Of those industries, only two are expected to be negatively affected by growth in corporate profit. Although the exact effects of the tax plan on the total value of corporate profit are unclear, an overall increase is highly expected. While certain provisions may weigh on the first few quarters of earnings, the effect over the next several years is largely expected to cause an increase. This is, however, restricted to companies with high levels of deferred tax assets on their books; as the tax rate falls, this will reduce the amount of allowed deferred tax assets, resulting in a large one-time charge.
Conversely, the large number of companies that have deferred tax liabilities and highly capital-intensive operations stand to gain, with the magnitude of these gains being driven by the individual industry’s sensitivity to corporate profit. IBISWorld expects that, all else equal, 188 industries will likely experience heightened demand. While many factors contribute to year-over-year revenue change, greater corporate profit is expected to have a positive effect on revenue.
Of this wide range of industries, which encompasses almost all sectors of the economy, professional, scientific and technical services (NAICS: 54) will likely be one of the most affected, with four industries being the most sensitive to corporate profit. Additionally, while they may not be the largest or fastest-growing, the magnitude of positive demand as a result of a corporate profit increase is expected to be greatest in the following industries: party and event planners, management consulting, company research services and forensic accounting services.
The primary link between corporate profit and demand for these industries is a focus on other businesses as the primary downstream market. As corporate profitability increases, this tends to result in an increase in spending on businesses services. For example, when the Party and Event Planners industry’s markets are broken down, IBISWorld estimates that 43.1% of demand is accounted for by businesses. Therefore, while consumers account for the majority of revenue, business demand is structurally important to the industry. The relationship between the other industries and corporate profit can be similarly explained; however, the remaining three industries almost exclusively provide their services to other businesses. As a result, the effect of higher corporate profit is typically twofold. For example, as corporate profit increases, demand for company research services expands on two fronts: greater corporate profit likely increases available spending on services while also increasing the value of company research activity. Greater corporate profit performance tends to increase equity trading volume and increase cash on hand for companies to attempt acquisitions, both of which drive demand for company research.
Despite rising corporate profit’s positive influence on certain industries, other industries are expected to be negatively affected by the increase. In general, a negative relation between industry demand and corporate profit can be attributed to an industry’s counter-cyclical nature. That is, some industries tend to thrive as macroeconomic indicators wane, and these specific industries are particularly tied to corporate profit—the most notable being invoice discounting. Greater profitability can reduce lending risk and make debt conditions more favorable, as is likely the case in the 181 industries positively related to corporate profit. Improving aggregate business profit tends to coincide with a greater level of overall business confidence. Therefore, demand for invoice discounting, which provides short-term financing for business invoices or accounts receivables, should fall. A more favorable position for companies to finance operations with cash or better loan conditions reduces the need for companies to turn to short-term financing.
Capital Expenditure Ramifications
Private investment in capital, while typically something that increases in line with corporate profit, benefits from specific portions of the tax bill beyond the reduced corporate tax rate. These changes, namely the adjustments to deductions on capital equipment, are expected to affect the larger economy. Although profit typically flows to private investment, the direct effect of higher investment has a strong effect on a range of industries. Private investment is measured in the form of many industry drivers, including aggregate private investment, as well as private investment in computers and software, industrial equipment and machinery, manufacturing structures and metalworking machinery. Regardless of the type, a form of private investment is identified as a key driver for 94 unique industries.
Similar to the effect of corporate profit, private investment is essential to a range of sectors. However, unlike corporate profit, private investment is more important to the manufacturing sector (NAICS: 31-33). This connection between capital investment and revenue for manufacturing industries is fundamentally driven by the manufacturing sector’s typical position in the supply chain, as operators in this sector both produce and demand final and intermediary goods. Take, for example, semiconductor and circuit manufacturing. The primary purchasers of this industry’s products are in the manufacturing sector, but the primary sellers to semiconductor manufacturers are also in the manufacturing sector. Any regulatory activity that incentivizes private investment is likely to have positive ramifications at each point in the supply chain. Investment in new machinery to help build products in downstream industries supports increased production of semiconductors that are used as inputs, which in turn incentivizes investment into new machinery for semiconductor manufacturers. This investment activity can drive demand for semiconductor machinery manufacturing. The supply chain linkages are significantly more intricate in practice, and industry revenue is not a function of change in a single variable. However, the ramifications of potentially increasing private investment are likely to have widespread industry effects.
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