December 20th, 2017
Tax Changes Trump the Interest Rate Hike
The recent 0.25-percent fed funds rate increase and three rate hikes planned for 2018 have raised the question of whether home remodeling and construction will suffer as a result. There is reason to believe that the tax plan recently passed by Congress will outweigh these interest rate hikes in their impact on the economy.
For historical perspective, the fed funds rate stands at 0.75 percent, having dropped as low as the essentially zero level of 0.25 percent in late 2008. Even after the third predicted rate hike in 2018, the fed funds rate will only have risen to 1.5 percent, still extremely low by historical standards. The highest fed funds rate ever was 20 percent during the stagflation era of 1979-1980.
An increasing interest rate environment can knock potential home buyers off the fence. Market timers now see that rates are going nowhere but up from here. First-time home buyers are out in record numbers and builder confidence has surged. The American dream of homeownership has regained some of the luster it lost in the last recession. Interest rates one or two percent higher than rock-bottom levels are not enough to deter aspiring home buyers.
Other things being equal, an increase in interest rates should decrease demand for new-construction and remodeling projects. Today, however, other things aren’t equal, they’re changing. The pending tax plan includes several tax cuts that are likely to spur spending on construction and remodeling. The largest tax cuts, both in terms of raw percentage points of tax paid and as a percentage move in the starting point of the tax rate, will benefit middle-class taxpayers. A 3-percent tax decrease for a family earning $150,000 annually leaves an additional $4,500 in their pocket at year’s end. It won’t buy a house, but it will fund a small remodeling project.
On the corporate side, a decrease in the corporate tax rate from 35 percent to 21 percent could easily spur the repatriation of billions of the estimated $2.6 trillion in cash that U.S. corporations currently hold overseas. Much of this windfall of cash will be invested in the refurbishment or construction of hotels, research labs, office buildings and other commercial structures.
In short, the pending tax cut looms much larger than potential interest rate hikes in driving growth.
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