Tax Reform:
CPI Plus More

December 19, 2017  | by Sharad Samy, Keith Luke, Catherine Keating

Governance and Policy | Industry Knowledge

It was another taxing weekend (literally) at Commonfund as we digested 1,097 pages of the conference agreement for the tax reform bill (the “Tax Act”) and its implications for our country and for the nonprofit and public sector investors we serve.

We focused on the Tax Act’s provisions, but also its wider goal of stimulating economic growth. We also attempted to discern the implicit preferences and philosophy of this first piece of major legislation from our nation’s 115th Congress, which is expected to be passed later this week, and its implications for public policy in the years ahead.

At-a-Glance

TABLE-At-a-Glance

The Tax Act appears to be more generous to corporations than to individuals. This signals a business policy preference by the Administration and Congress, as business investment represents 13 percent of the U.S. $19 trillion economy, while consumers represent more than two-thirds.

CHART1-TaxCutsv2

Supporters of the Tax Act hope that it will stimulate the economy by promoting business investment and ultimately increasing consumer spending. Congress is acting at a time when, in the aggregate, businesses and consumers have recovered from the financial crisis, and corporate profitability and household net worth have reached all-time highs:

CHART2-CorpProfits-Householdworth

Corporate Tax Cut Implications

Businesses have many constituents, including employees, regulators, communities, and shareholders. But the one constituent to whom a company, its board and its officers owe a fiduciary duty is its shareholders. Given this fiduciary duty, we expect that shareholders will be significant beneficiaries, including through higher profits, increased dividends and more stock buybacks. As we have shared previously, we expect that the tax cut will contribute to higher earnings with an increase of eight to ten percent likely next year directly attributable to tax cuts. Beyond the corporate tax reductions, the Tax Act intends – as signified in its title – to stimulate job and wage growth through further business investment. Our investment teams will be monitoring job creation and wage growth and their potential to impact inflation.

Individual Tax Cut Implications

Unlike the corporate tax changes, the individual tax cuts in the Tax Act are temporary and will sunset at the end of 2025. Most taxpayers will see modest tax reductions due largely to lower rates and changes in the AMT. However, the limitations on deductions for state and local property and income taxes, mortgage interest and home equity loans, as well as the repeal of the individual mandate under the Affordable Care Act (which is expected to lead to an increase in health care costs as healthier participants drop coverage) are significant. Taken together, the magnitude of the tax benefits to individuals, offset by potentially higher healthcare costs, is estimated to be less than $1 trillion, or less than half that afforded to businesses.

Nonprofit Sector Implications

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More broadly, the impact of the Tax Act on nonprofits is likely to be felt as a derivative of the increase in the standard deduction. Data informs us that itemizers are far more likely to donate to charity than non-itemizers. In fact, 83 percent of itemizers report giving to charity compared with only 44 percent of non-itemizers. Non-itemizers contribute less than 20 percent of total charitable giving. The Tax Policy Center released a study in November that estimated this legislation could decrease charitable giving by $12.3 – $19.7 billion in 2018.2

The Big Picture

At Commonfund, we believe that the Tax Act is the most significant package of tax changes for companies and consumers since the Reagan-era changes of 1986, and for nonprofits since the Nixon-era changes of 1969. It is generational change. It reveals an implicit economic preference of the 115th Congress: a preference for businesses over other segments of the economy, including consumers, government and large nonprofits. It also suggests a philosophy of cultural self-reliance, reflected in a myriad of ways including the repeal of the individual mandate, limitations on deductions of state and local taxes and mortgage interest, expansion of savings incentives under 529 plans, and maintenance of current personal retirement savings incentives.

We will not know for years whether the Tax Act succeeds in its goal of growing our economy in a sustainable way. But we know that our clients in the nonprofit and public sector support those who are not in businesses and who may not be self-reliant: our citizens who need education, healthcare, public safety, secure retirements, and art and culture in their lives. This work has always been important, and will be even more important as our society and economy adjust to a generational change in taxes, preferences, and philosophy.

An Ongoing Commitment to Mission: CPI Plus More

The nonprofit and public sector investors we serve at Commonfund have the longest time horizons but also the highest return targets. Their returns need to exceed inflation plus annual distributions in the range of five percent, or in our investment shorthand, “CPI plus 5.”

Looking ahead, we are cognizant of potential unintended consequences and excluded beneficiaries of the Tax Act. We are approaching the tenth year of the post-crisis recovery, with business profits and household net worth at all-time highs, and interest rates still near cyclical lows. We hope that Congress succeeds in stimulating business investment and consumer spending, and growing the economy for all.

We are also aware of the cyclical implications of the Tax Act. It benefits companies and their shareholders, who have been significant beneficiaries of loose monetary policies over the past nine years. It increases the national debt substantially, and may trigger inflation, which could hasten an end to the current business cycle. At the same time, it likely increases the needs of underserved populations supported by nonprofits and the public sector, at a time when charitable giving may decrease. For us at Commonfund, this means we will be focused on “CPI plus more.” Looking ahead, we believe our clients’ portfolios may need to earn returns sufficient to cover both higher inflation as well as higher constituent needs. Sustaining nonprofit and public investors has never been easy, but that has been our mission for almost five decades and will remain our mission over the years to come.

1 Source: Cornerstone Macro, December 17, 2017. Corporate/business tax cuts of $2 trillion represent gross tax cuts from major business provisions of Act. Individual/Consumption tax cuts of $1.2 trillion represent changes in income tax rates for individuals.

2 Source: Tax Policy Center, Urban Institute and Brookings Institution, November 2017. See http://www.taxpolicycenter.org/taxvox/house-tax-bill-not-very-charitable-nonprofits

Authors

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Keith W. Luke is responsible for firm-wide client relationship management and business development. In this capacity, he and his team provide OCIO and private capital solutions to nonprofits and public sector investors. He is President of Commonfund Securities, Inc., the firm’s registered broker-dealer subsidiary, and is also responsible for managing Commonfund's marketing, and for overseeing educational programs and research in concert with Commonfund Institute. He serves as a member of the Commonfund Operating Committee. Prior to joining Commonfund, Keith was in commercial banking for 19 years, most recently at Citibank, where he held a number of marketing and strategic planning positions in The Private Bank and Corporate Bank. Prior to Citibank, he was with HSBC USA (formerly Marine Midland Bank) in corporate finance and investment banking. Keith earned a B.A. in Economics at Duke University and an M.B.A. in Finance from NYU Stern School of Business.
Keith W. Luke
President, Commonfund Securities, Inc.
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Sharad Samy serves as General Counsel of Commonfund. Prior to Commonfund, he was the General Counsel of Aladdin Capital Holdings LLC, a global hedge fund with $22 billion assets under management at its peak with a registered investment advisor and registered broker-dealer subsidiary. Prior to joining Aladdin, Sharad was a partner of Orrick, Herrington and Sutcliffe LLP in its Financial Markets Group, resident in its London and New York offices. He has worked extensively in both London and New York and has covered cross-border transactions involving jurisdictions in North America, South America, Europe, Africa and Asia for offerings in the United States and European capital markets. From 1997 through 2008, Sharad was a Judge Advocate for the U.S. Army Reserve, having served in the Horn of Africa in connection with Operation Enduring Freedom and leaving the service with the rank of Major. In addition to his professional activities, Sharad is a member of the board of directors of The Child Guidance Center of Southern Connecticut and is a friend of the board of directors of A Better Chance, Darien. He is also the Judge Advocate for Post 6933 of the Veterans of Foreign Wars. Sharad is a graduate of Columbia College with A.B. in Political Science and received a J.D. from Columbia University Law School and he is admitted to practice law in the State of Connecticut and the State of New York.
Sharad Samy
General Counsel
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Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.