January 24, 2018

Thornburg is a global investment firm delivering on strategy for institutions, financial professionals and investors worldwide.

Tax Reform Moves the Needle on U.S. Corporate Tax Competitiveness

If U.S. tax reform modestly boosts economic growth and deepens the fiscal deficit, its benefits for smaller companies are significant. It also ends incentives that spurred bigger U.S. firms to decamp to lower-tax jurisdictions abroad.

thornburg.com

8 7 7. 2 15 .13 3 0

The tax overhaul is the most sweeping in decades and puts most

U.S. firms on more competitive footing vis-à-vis overseas corporate

tax regimes. Smaller businesses with a domestic focus and little abil

ity to lower their effective tax rates will benefit the most. Many com

panies should have more scope to invest, raise wages, cut prices,

pay down debt, or return the tax savings to shareholders. The reform

could affect corporate capital structures. It could even impact finan

cial sector holdings of municipal bonds. But just how much it adds to

economic growth and the fiscal deficit and how it figures into mone

tary policy, remains to be seen.

Featured Inside

• The tax reform, along with the reduction in regulation, should modestly boost economic growth,

particularly over the next few years. But it could also add to the fiscal deficit and federal debt

load at a time of rising benchmark interest rates, possibly reducing the economic tailwinds.

• The tax reform should be more inflationary than deflationary. Given that valuations for most

assets—including U.S. equities, as well as high-yield and investment-grade debt—are on

the richer end of fair value, the margin for error appears limited.

• But a lower cost of capital should stimulate investment, increase productivity growth, and

raise potential gross domestic product. Lifting long-stagnant productivity growth is the key to

rising wages. Small businesses, which account for nearly two thirds of net new jobs, should

especially benefit from lower taxes.

• The reform’s shift to a territorial from a worldwide-taxation system should reduce tax inver

sions by U.S. corporates, which will also have to pay one-off taxes on their past earnings

parked overseas.

Tax Reform Moves the Needle on

U.S. Corporate Tax Competitiveness

Januar y 2018

Charles Roth | Global Markets Editor

The U.S. has passed its biggest tax reform

in more than three decades, meaning

fully raising the tax code’s competitiveness

in the world’s largest economy. The $1.4

trillion, 10-year overhaul cut the corporate

income tax rate to its lowest level in nearly

six decades, while most individuals will also

see smaller federal assessments on their

earnings.

The package is likely to lift economic growth

0.2 percentage points to more than 0.4 per

centage points in 2018, with projections for

2019’s boost ebbing a bit, as the reform is

relatively front-loaded. Its long-run fillip to

gross domestic product (GDP) is projected

anywhere from 0.7%, according to the Joint

Committee on Taxation’s static-scoring

forecast, to the Tax Foundation’s dynami

cally scored 1.7%.

Such forecasts are always slippery. Incentive

effects that spur greater corporate invest

ment and consumer spending will also spur

faster economic growth, but how much

it offsets the revenue loss of lower taxes is

hard to predict. Any shortfall will result in

higher budget deficits without lower gov

ernment spending. Yet fiscal outlays are

likely to increase due to rebuilding efforts

following a heavy 2017 hurricane season

and the Trump administration’s broader

push to boost infrastructure spending. That

suggests the plan won’t be revenue neutral

anytime soon, deepening the fiscal deficit by

a point or two from 3.5% of GDP at the end

of 2017 and further increasing federal debt

that is already more than 100% of GDP. A

heavier debt load would also come at a time

of rising benchmark interest rates, which, in

addition to raising interest costs on the debt,

also factor into the pace of GDP growth.

The Federal Reserve is expected to hike

three to four times in 2018, pressuring the

short end of the yield curve at the same

time that it’s gradually reducing the size of

its balance sheet. The “quantitative tight

ening” will continue amid two more slated

key rate hikes in each of the following two

years. A more aggressive Fed could slow the

economy, which would then spin off less tax

revenue. At its December meeting, the Fed

raised its 2018 GDP forecast four-tenths of

a point to 2.5%, even as the economy has

lately been running well-above that pace: in

the April-through-September period, it was

chugging at more than 3% annual growth.

Yet the Core PCE Index, its preferred infla

tion measure, hasn’t been close to the 2%

target for nearly a year, despite unemploy

ment receding to 4.1%.

Some argue that slack remains in the labor

market. The labor participation rate is still

at four-decade lows. And, as Deutsche

Bank’s Torsten Slok points out, the main

reason long-awaited wage growth has been

slow to materialize is that people have been

more or less steadily returning to the labor

market since 2013, easing the pressure on

employers to hike salaries. Given the econ

omy’s momentum, the Fed expects the labor

market to tighten further, forecasting 2018

unemployment of 3.9%.

The tax reform and the White House’s

deregulation efforts create tailwinds for

employers to invest in both labor and cap

ital. Major companies, including AT&T,

Comcast, Fifth Third Bancorp, The Home

Depot, and Walmart, among others, have

already declared increases in entry-level

salaries, bonuses, or investment spending.

Critics of the reform point out that major

companies already had a lower effective

corporate tax rate thanks to loopholes and

accounting wizardry. But proponents note

that smaller businesses, which account for

about half of private sector payrolls and

nearly two-thirds of net new jobs, should

benefit from lower taxes and a more level

playing field. All in all, as the Fed’s out-go

ing Janet Yellen noted in her last remarks as

chairwoman to the press, the tax overhaul

should lower the cost of capital, stimulate

investment, increase productivity growth,

and raise potential GDP. Lifting long-stag

nant productivity growth is the key to lift

ing wages, and, potentially, inflation.

After the December policy meeting, Yellen

also pointed out that the

Tax Cuts and Jobs

Act

has “some potential to boost aggregate

supply.” It’s definitely a supply-side reform.

At 35%—or 39% including state taxes—the

nominal U.S. corporate tax rate was the

highest in the developed world. It created an

incentive for U.S. companies to relocate to

more competitive tax jurisdictions via merg

ers called tax inversions. The reform reduces

the rate to 21%, three points below the

average statutory corporate tax rate in the

Organization for Economic Cooperation

and Development. Businesses will also

enjoy an immediate write-off on capital

investments, and the corporate alternative

minimum tax has been eliminated.

The reform also moved the U.S. from a

world-wide taxation system, in which U.S.

firms were effectively taxed at the previ

ous U.S. rate on their foreign income, to a

territorial system, which only taxes income

earned within a country’s border. That’s how

most countries handle their multinationals’

foreign earnings. As a result of the U.S.’s

previous high corporate tax and world-wide

taxation approach, some $2.6 trillion in cor

porate profits are parked overseas. As part of

the reform, U.S. firms will be taxed on those

foreign earnings at a 15.5% rate, and an 8%

levy on other, illiquid assets abroad. U.S.

banks, tech and pharmaceutical companies

with world-wide operations will be hit with

billions of dollars in one-off charges. As

noted, many had a lower effective tax rate,

and so won’t see as much benefit from the

tax reform as their smaller domestic peers.

Yet by forgoing convoluted, tax-driven

domicile and financial engineering strate

gies, over the long run they could also come

out more or less even, or potentially ahead

with the lower domestic corporate tax rate

and territorial tax system.

On the individual side, most people mak

ing tax payments will see tax cuts over

the next few years, though after 2021, the

Joint Committee on Taxation warns some

low-income taxpayers might effectively see

a net tax increase due to the elimination of

the Affordable Care Act’s individual man

date and subsequent cut in health insurance

subsidies. They number an estimated 5%. In

2019, nearly a quarter of the aggregate tax

cut—about $61 billion, or an average cut of

$1,600—will go to middle-income earners

making between $20,000 and $100,000 and

representing about half of all tax filers. Given

the progressive structure of the tax system,

the bulk of the tax cut will go to higher-in

come groups, with 52% headed for those

with incomes of $100,000 to $500,000.

Around 23% will go to the “one-percenters”

making more than $500,000 per year.

As for the debate over the contribution

to GDP growth from increased personal

consumption as a result of more dispos

able income through the tax cut, it’s worth

noting that, at 2.9% in November, the U.S.

personal savings rate is at its lowest level

in a decade. Higher-income groups might

Tax Reform Moves the Needle on U.S. Corporate Tax Competitiveness

save or invest more of the tax savings than

spend it. In any event, the Conference

Board’s Consumer Confidence Index rose

to its highest level in November since 2000.

Animal spirits have also been stoked, with

the National Federation of Independent

Business Optimism Index nearing a record

high in November, a level it nearly matched

in December and making 2017 the highest

year on record. Investors clearly like what

they see in the tax reform, driving U.S.

bluechip equity indices to record highs in

anticipation of the tax reform, and in the

weeks following it, as well.

As a bottom-up investment shop, Thornburg factors tax rates into its model assumptions as just one

element of its fundamental securities analysis. Thornburg’s Christian Hoffmann,

cfa

, Rob McDonald,

cfa

, and Nicholos Venditti,

cfa

, weigh in on the discreet impacts the tax reform should have in particu

lar sectors of the market and for investors.

The spread between 10-year and two-year

U.S. Treasuries has compressed since the

beginning of 2014, shortly after the Fed first

flagged the “tapering” of quantitative eas

ing and subsequent, albeit gradual, rate

hikes. Historically, a flattening yield curve

often portended an inversion in the curve,

followed by recession. Do current economic

conditions and the tax reform suggest that

this time is different? Also, after consider

able tightening in high-yield and high-

grade corporate spreads in 2017, how much

lower can spreads go in 2018, especially

given liquidity risks associated with the

Fed’s monetary tightening.

Christian Hoffmann:

Undue emphasis on

any one data point or ratio ignores the com

plexity and interconnectivity of the global

economic landscape. Much has been made

of the flattening yield curve, but the flatten

ing has been driven by rising short-term

rates, which have been driven by Fed actions

that the vast majority of investors believe are

long overdue. Interestingly, the 10-year

Treasury ended 2017 almost exactly where it

started the year.

The Fed increasing short-term rates should

assuage inflation fears, which are most

apparent in the longer end of the yield

curve. It’s worth mentioning that investors

are still taking a relatively sanguine per

spective toward inflation risk and that at

the margin, tax reform should be more

inflationary than deflationary.

Another factor to consider is the global mar

ketplace for assets. Compared to the vast

majority of the world, Treasuries still offer

compelling relative value among govern

ment debt issuers—remember that 10-year

German bunds yield not even one-fifth of

10-year Treasury yields.

The world of early 2018 points to an environ

ment of reasonable global economic growth

and subdued inflation. On the other hand,

valuations for most assets—including U.S.

high-yield and investment-grade debt—are

on the richer end of fair value. The margin

for error appears limited. It seems fairly clear

that we are in the later innings of an eco

nomic cycle, and there is virtually an endless

list of events that could disrupt-to-nega

tively shock the marketplace.

In recent years, U.S. businesses have bene

fited from the “bonus depreciation deduc

tion” of 50% on new equipment, and aggre

gate non-residential fixed investment has in

fact been growing since mid-2016. While

the reform’s 100% expensing of capital

investment over the next five years will

include both new and acquired equipment,

do you expect much of an increase in aggre

gate corporate investment?

Rob McDonald:

I would expect a modest

increase in corporate investment due to the

change in tax treatment for equipment. The

tax law change will pull forward some pur

chasing that would have taken place at a

future date. On the margin, overall equip

ment demand could increase a

little—equipment purchases that didn’t quite

make the return hurdle historically—may

make sense post tax reform.

Q: Do you anticipate a decrease in tax inver

sions, given the lower U.S. corporate income

tax rate and the move to a territorial from a

worldwide taxation regime?

Rob McDonald:

I would expect a decline in

tax inversions going forward. The govern

ment has tried to prevent companies moving

abroad for some time. This tax reform plan

decreases the attractiveness of domestic com

panies moving out of the United States.

The U.S. retail sector pays an average corpo

rate tax rate of about 31%, as retailers gener

ally import many of their products and can’t

deduct much from research and development

initiatives. So the sector, much of which has

come under pressure from the “Amazon

Effect,” stands to benefit. Do you expect

retailers to lower product prices to better

compete, or do you think they might gener

ally use the tax savings to pay down debt,

invest or return more of it to shareholders?

Rob McDonald:

In thinking about financial

impacts of tax reform, the first question is

how much a company’s tax rate will decline.

The second question is, can that company

keep the savings or does it have to give it to

customers? Retail is a tough business, where

you have to evolve or die. Some of the tax

savings will have to be passed along to con

sumers through lower product price or

investments in stores.

Q: The net interest deduction is now capped at

30% of EBITDA for four years, and 30% of

EBIT thereafter, ending the full deduction

of interest payments. Do you expect that this

will push more companies, particularly

non-investment-grade corporates that are

generally subject to higher interest rates on

debt issued, to finance themselves less with

debt versus equity going forward?

Rob McDonald:

The new tax law will push

company capital structures to a higher mix of

equity and lower debt.

Q: In the prelude to the tax reform, the munici

pal bond market saw a gusher of issuance,

with sales of both refinancing and new

paper in December alone totaling approxi

mately $64 billion, a record high. Prices

plunged relative to U.S. Treasuries on the

supply wave, only to climb back up as inves

tors snapped up the lower-priced munis. In

Tax Reform Moves the Needle on U.S. Corporate Tax Competitiveness

Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or sum-

mary prospectus containing this and other information, contact your financial advisor or visit thornburg.com. Read them

carefully before investing.

Thornburg Funds are distributed by Thornburg Securities Corporation.

1/17/18

TH4085

its final version, the tax reform did away

with the exemption on advance refunding

bonds, which cities and states use to refi

nance older debt, but retained the exemption

on private-activity bonds, which non-prof

its and some for-profits turn to for projects

deemed of public benefit. Are fears of less

muni market supply ahead as a result of the

end of advance refunding bonds warranted?

Also, marginal rates on top earners,

although a bit lower with the tax reform, are

still relatively high. Coupled with the new

$10,000 limit on state and local tax (SALT)

deductions for married couples (and $5,000

for individuals), do you expect more taxable

income to shift to low or no income tax states

from high tax states?

Nicholos Venditti:

I am not convinced that

the elimination of advanced refunding bonds

will have a material impact on supply in the

short term. While it is certainly true that

refunding bonds have been a major driver of

supply over the past several years, it is import

ant to remember that the economic benefit of

refunding debt is predicated on lower interest

rates. To the extent that we believe rate pres

sure is shaded higher, the market likely would

have seen substantially less advanced refund

ing issuance in the near term, regardless of

tax reform.

The issue of outmigration is more inter

esting, albeit a longer-dated problem.

Demographic trends have long been a

cornerstone of credit analysis. Population

declines have had a material impact on issu

ers in the past, largely due to the death of

manufacturing. The financial problems in

places such as Detroit, Buffalo, steel towns

in Pennsylvania, and even Puerto Rico, all

have been exacerbated by loss of the tax base.

An increased tax burden that encourages

people to vacate for greener, or in this case

cheaper, pastures is absolutely a possibility.

But the SALT limit and a lower cap on

mortgage interest deductions actually

make munis that much more attractive

for high-income individuals. And that, in

turn, partially offsets the negative impact

that the lower corporate tax rate has on the

muni market, of which banks and property

and casualty insurers own roughly 15% and

10%, respectively.

The tax reform’s repercussions on relative

valuations and risks in the muni and other

markets once again highlight the absolute

necessity of quality, fundamental research.

At Thornburg, we have built a 30-plus-year

franchise focused on disciplined, bottom-up

analysis and are more than equipped to nav

igate the changing market dynamics.

IMPORTANT INFORMATION

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or

investment advice and is not intended to predict the performance of any investment or market.

Alternative Minimum Tax (AMT) – A federal tax aimed at ensuring that high-income individuals, estates, trusts, and corporations pay a minimal level income tax. For individuals, the AMT is calculated by

adding tax preference items to regular taxable income.

Animal spirits – A term coined by John Maynard Keynes to describe human emotion that drives consumer confidence.

Bond Credit Ratings (Credit Quality) – A bond credit rating assesses the financial ability of a debt issuer to make timely payments of principal and interest. Ratings of AAA (the highest), AA, A, and BBB

are investment-grade quality. Ratings of BB, B, CCC, CC, C and D (the lowest) are considered below investment grade, speculative grade, or junk bonds.

Consumer Confidence Index – The Consumer Confidence Index is an index by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the

near future.

Core Personal Consumption Expenditure Index is a measure of the Personal Consumption Expenditure Index that excludes the more volatile and seasonal food and energy prices.

Credit Spread/Quality Spread – The difference between the yields of securities with different credit qualities.

EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization. An approximate measure of a company's operating cash flow based on data from the company's income statement.

NFIB Small Business Optimism Index – The National Federation of Independent Business (NFIB) Small Business Optimism Index is a composite of 10 seasonally adjusted components and provides an

indication of the health of small businesses in the U.S.

Quantitative Easing (QE) – An unconventional monetary policy in which a central bank purchases financial assets from the market in order to lower interest rates and increase the money supply.

P/E – Price/Earnings ratio (P/E ratio) is a valuation ratio of a company’s current share price compared to its per-share earnings. P/E equals a company’s market value per share divided by earnings per

share. Forecasted P/E is not intended to be a forecast of the fund's future performance.

Yield Curve – A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates.

Securities mentioned herein are for illustrative purposes only and are presented to describe the due diligence process for purchasing or selling an individual stock. Under no circumstances does the

information contained within represent a recommendation to buy or sell any security. This information is current as of the date indicated and represents current holdings of Thornburg; however, there is

no assurance that any security referenced will remain in any portfolio and Thornburg undertakes no obligation to update the information or otherwise advise the reader of changes in its ownership of the

holdings. It should not be assumed that any of the referenced securities were or will be profitable or that the investment decisions we make in the future will be profitable.

Investments carry risks, including possible loss of principal. Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations,

illiquidity, volatility, and political and economic risks. Investments in small- and mid-capitalization companies may increase the risk of greater price fluctuations. Portfolios investing in bonds have the

same interest rate, inflation, and credit risks that are associated with the underlying bonds. The value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. This

effect is more pronounced for longer-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. Investments in mortgage-backed securities (MBS) may bear additional risk. Investments

in lower rated and unrated bonds may be more sensitive to default, downgrades, and market volatility; these investments may also be less liquid than higher rated bonds. Investments in derivatives are

subject to the risks associated with the securities or other assets underlying the pool of securities, including illiquidity and difficulty in valuation. Investments in the Funds are not FDIC insured, nor are

they bank deposits or guaranteed by a bank or any other entity.

Fund Holding Weights as of 11/30/17

Thornburg Core Growth Fund:

Comcast, 2.05%, Walmart, 2.75%.

Thornburg Investment Income Builder Fund:

AT&T, 1.37%; The Home Depot, 2.21%.

Thornburg Limited Term Income Fund:

AT&T, 0.80%; Fifth Third Bancorp, 0.08%.

Thornburg Low Duration Income Fund:

AT&T, 0.88%; Fifth Third Bancorp, 0.89%.

Thornburg Strategic Income Fund:

AT&T, 0.22%; Comcast, 0.92%.

Thornburg Value Fund:

Walmart, 4.19%.

Companies mentioned in the article but not listed above were not held in the above-mentioned Thornburg funds as of 11/30/17.

Disclaimers & Disclosures

To learn more, please visit www.thornburg.com

The views expressed by the portfolio managers reflect their professional opinions and are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security. Investments carry risks, including possible loss of principal. Investments carry risks, including possible loss of principal. Portfolios investing in bonds have the same interest rate, inflation, and credit risks that are associated with the underlying bonds. The value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. Unlike bonds, bond funds have ongoing fees and expenses. Investments in the Funds are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity. Please see our glossary for a definition of terms: http://www.thornburg.com/legal/glossary.aspx Thornburg mutual funds are distributed by Thornburg Securities Corporation. Thornburg Investment Management, Inc. mutual funds are sold through investment professionals including investment advisors, brokerage firms, bank trust departments, trust companies and certain other financial intermediaries. Thornburg Securities Corporation (TSC) does not act as broker of record for investors.

Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit our literature center. Read them carefully before investing: https://www.thornburg.com/forms-literature/product-literature/mutual-funds/index.aspx

More from Thornburg Investment Management