New corporate tax regime – Boom or bust?
Corporate taxes are now lower but not simpler. Changes include reducing the corporate tax rate from 35 percent to 21 percent, mandating a one-time repatriation of offshore profits at a rate of 15 percent for cash and 8 percent for illiquid asset, and a new break for small businesses by creating a 20 percent tax deduction for sole proprietors and partnerships. In addition, businesses will be able to write off capital equipment immediately instead of depreciating it over a number of years.
The lowering of corporate rates is expected to stimulate US GDP which is already running at the 3 percent level. Expectations are that increased investment in the economy will drive corporate earnings during the next leg of the expansion. Analysts will be watching closely to see whether this investment materializes and whether employee salaries begin to rise after years of stagnating wages. This extra corporate cash could drive mergers and acquisitions in mid-market technology but high valuations may continue to put a damper on the largest transactions. Expect the added cash reserves to lead to executive pay increases, share buybacks and higher dividend yields. Enhanced cash reserves will also benefit corporate investment even if interest rates grind higher. Corporate borrowing will continue to fund growth but larger cash reserves should mitigate some borrowing needs.
The 21 percent corporate tax rate gives the US a comparative advantage and should, over the long term, drive increased international investment. Germany and Japan have corporate rates of 30 percent, while France is 34 percent. According to the OECD, among the larger economies only the UK has a lower rate of 19 percent. Skepticism concerning the new tax regime falls into three camps. The first group is concerned the tax decrease will blow the deficit out of the water. Expectations for 2018 and 2019 are deficits approaching 800 billion to 1 trillion per annum, extraordinary sums that will need to be paid as interest rates at the short end of the curve slowly move higher. The second group believes the tax benefits will end up in the hands of corporate executives taking massive salary and option packages. At a time of great income inequality there is fear of further alienating the large number of Americans just getting by. The third group of skeptics are concerned that lowering corporate tax rates could lead to tax competition and a global race to the bottom. How will Germany, Japan and other industrial countries react, will they lower tax rates in response, and could this lead to a decline in global tax receipts at a time of increasing government responsibility as our populations age.
The counter argument is that increased growth will be driven, in part by tax cuts, leading to an increase in national wealth. The argument is that innovation and productivity are driven by disruption and technological innovation. Lowering corporate taxes will provide the investment capital, according to this argument, to drive national prosperity. The ability to write off capital equipment immediately should lead to increased investment as well as corporations realize the tax advantages of locating factories in the US. In addition, the 20 percent tax break for individuals filing as a pass-through sole proprietorship or partnership will benefit this entrepreneurial class. A majority of new jobs in the US are created by small and medium size companies and, so the argument goes, increased cash flows will lead to new hires and new waves of innovation. Whether or not the new tax regime is a net benefit to the US economy will be an important factor in the November 2018 midterm elections. The Trump administration needs to show the American public that they are sound managers of the US economy. The midterms already look like tough sledding for the Republicans. They need to win the economic argument as they fight to maintain power in these divisive times. There is much to play for politically and we can be assured that the impact of tax reform will be center stage in the political battles to come.
January 09, 2018