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Smythe: Invest tax cuts to improve economy

Banking & Finance
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While staying away from predicting the ups and downs of the economy in 2017, Thomas Smythe, business and accounting professor at Furman University, said there are some things to be aware of this year. He provided some economic insights prior to the end of 2017, including his thoughts on the stock market, employment and the state economy.

 

2017 saw the stock market break records. Can we expect similar strength in 2018?

Smythe: Many would like to attribute the stock market’s rise to the election of Donald Trump, but there are many factors that impact the stock market. There is no doubt that expectations regarding lower taxes and reduced regulations had positive impacts on the market; however, there are a number of other factors that have also played a role. The first is world economic growth.

2017 is the first year in approximately a quarter century where all major developed markets grew at the same time. In fact, while the U.S. market has done exceptionally well, markets in Europe have actually performed better. In relative terms, the U.S. has underperformed. Some of that is likely a function of those markets having been suppressed for an extended period, but may also may be concern on the part of U.S. investors over future U.S. trade policy.

Thomas Smythe

The Trump administration, by withdrawing from TPP (Trans-Pacific Partnership) and renegotiating NAFTA, is sending strong signals that the U.S. will become more protectionist during his administration. Given the global nature of business, especially here in the Upstate, investors may be wary in relative terms.  Second, I believe that investors in the U.S. have been in a post-2007 hangover period. The fundamentals of the economy have been strong for almost seven years, yet markets have taken a long time to reward that strength. Finally, while the Federal Reserve has raised rates three times in 2017, interest rates are still at historic lows, meaning yields on fixed income securities are still not good alternatives for investors, thereby leading investors to the stock market.

As for 2018, I wish I knew what the market holds. I do think there is more downside risk than upside in the short-term for three reasons, one of which will likely be resolved prior to the publication of this piece, and that is tax reform.

If Congress were not to pass it, the markets would respond extremely negatively. In other words, the market has priced in corporate tax reform. While there may be some upside if it formally passes, the market has largely built in the passage and if it did not happen, that would lead to a significant correction. Second, the market is at all-time highs in absolute terms but also in relative terms in terms of price-earnings ratios. At some point, there will be a correction. My final reason is tied to the first. If corporate tax reform passes, the market will look to see what companies do with the money. They really have two choices, invest for the long-term growth of the company or immediately reward shareholders with dividends and/or repurchases. The latter would lead to short-term increases in the market, but at some point, companies must invest for the future and the market will be watching.

 

The state and country are experiencing low unemployment rates. Is the job market saturated? Are there still jobs for those who are looking for employment?

Smythe: While unemployment rates are low, we had a large number of people leave the job market in the last 10 years. So, we know firms are looking for people, the question is whether those people on the sidelines can be enticed back into the market. If not, we should see wage growth pick up — good for those with jobs — but this could lead to faster paced inflation — bad for all.

The second track to answer this question is related to how companies might use cash from lower taxes. If they invest, there should be job creation, although not likely immediate. The problem is, companies have been extremely reluctant to invest in research and development, new physical assets and people over the last 10 years or so. They have chosen to pass profits to shareholders in the form of repurchases. While great for shareholders, this use of cash does not increase wages or create new jobs.

 

What would you say is the top strength of the South Carolina economy?

Smythe: Without question, I believe there are two factors that stand out as strengths: Our growing economic diversity and the strength of our technical school program. While we do have some concentration in the automobile industry, we are seeing a growing range of industries locating to South Carolina, from Boeing to TD Bank to Amazon and others. This growing diversity is also largely skill driven and our technical schools do a fantastic job of partnering with these new companies to provide the skilled workforce needed to land these types of investments. I also credit former Gov. Nikki Haley for her efforts in this area. She successfully recruited more industry to the state than anyone since Carrol Campbell. In my opinion, that will be her lasting legacy.

 

Is South Carolina in a position for continued economic strength?

Smythe: The answer is yes, but we cannot rest on our laurels. The passage of the gas tax increase in 2017 was a strong step politically. The reality is, industry needs transportation access, and while the Inland Port in Greer was a major improvement in that area, roads are still the bread and butter of industrial transportation. That means we need good roads. South Carolina roads in general are in rough shape. Repairing, improving and building new roads is critical to our economic strength. Again, the continued investment in our technical schools is critical, as is allowing them the ability to innovate to meet the needs of industry.

The area that I feel we are most lacking is investment in K-12 education.  Class sizes grew after 2007 and have never been reduced, yet one of the things almost everyone can agree on is that smaller classes lead to better outcomes. We are also facing a teacher crisis with a large wave about to retire and not as many new teachers coming into the system.

Quite simply, we do not pay teachers enough. Education is the greatest investment we as a society can make, yet South Carolina has taken every opportunity to reduce funding to public education. Starting salaries for teachers are only about $7,000 above the federal poverty income level. People respond to incentives; better pay will lead to not only more teachers, but better ones as well. I am not being critical of current teachers. My daughter-in-law is a passionate, exceptional third-grade teacher in a Title I school. I would like to see her and others rewarded for the incredible responsibility they have for the future of our state, and more like her be attracted to the profession. I am just saying that people who might be picking between a career as a scientist or teacher, may choose being a teacher if pay is more competitive.

 

What downturns might we see in 2018 on a state and national level? Upswings?

Smythe: I like to stay away from predictions, but there are several issues that we should keep our eye on. First is tax reform. ... The tax legislation has been largely handled behind closed doors. I think there will be provisions that individuals, and possibly corporations, will not recognize until about this time next year when we begin to think about filing taxes. People tend to be focused on rates, but this tax legislation will completely change the way we approach taxes.

Things that we have come to depend on such as the mortgage interest deduction and personal exemptions will either become irrelevant or be gone. On the personal side, rate reductions are set to expire in about eight years unless a new Congress extends them.  If these massive changes end up leading to significantly lower tax reductions than expected, we could see issues this time next year.

Also, how the U.S. approaches international trade could have an impact. If we move to harden our borders, it will hurt the economy. Prices will rise and demand for products made in the U.S. will fall. Finally, the political landscape could have an impact, anything from the Russia probe, continued revelations about sexual harassment by elected officials, to deteriorating relations with North Korea, all could help or hurt. It is these unknowns that make markets and economies variable. We just cannot predict how those events may impact us.

Reach Teresa Cutlip at 864-720-1223.

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