Here’s what Biden’s corporate tax plan means for investors
Multinationals may soon be forced to pay a higher share of their profits to the governments of the countries where they operate. “We will reform corporate taxes so that they pay their fair share,” President Biden said in his speech to Congress on Wednesday.
Biden’s “Made in America tax plan” would increase the statutory federal rate from 21% to 28%, remove incentives to off-site profits and production to tax havens, and impose a minimum tax of 15% on companies that report taxes. high profits to investors but little to no income taxable to the Internal Revenue Service. This would mark a major step towards an international deal to curb tax evasion that has been endorsed by finance ministers of many U.S. allies and end what Treasury Secretary Janet Yellen recently called the “30-year race.” down corporate tax rates ”.
The companies that generate most of their value from intangibles like software and pharmaceutical patents – and therefore had the easiest profits to shift over time to avoid the IRS – would be the most affected. Other sectors that have been less successful in protecting their profits from taxes, such as telecommunications, retailers and banks, could benefit on a relative basis. In fact, they might not be losers at all, especially if the proposed increase in the overall tax rate is reduced to 25% or less to protect other provisions.
Consider that America’s most tax efficient companies faced effective rates below the current 21% even before the Tax Cuts and Jobs Act, or TCJA, was passed in late 2017. According to one Barron’s analysis of company deposits,
Johnson & johnson
(MSFT) is one of the US multinationals that had effective tax rates of around 19% in the years preceding TCJA.
The main reason, which all companies make clear in their annual securities returns, is that they have been able to shift a large portion of their reported profits to jurisdictions where corporate profits are lightly taxed – if at all. be. TCJA did not change this basic dynamic, which is why it only reduced the annual tax burden of these companies by around four percentage points.
Biden’s plan would have a huge impact on these companies, even if the federal statutory rate remained constant at 21%, as it would ensure that all profits made abroad would be taxed at least 21%. If a foreign government had a corporate tax rate of 21% or more, the IRS would not collect anything, but any subsidiary in a jurisdiction where the tax rate is less than 21% would have to pay the difference to the IRS. .
Of the roughly $ 2.2 trillion in corporate profits made by U.S. companies in 2019, more than $ 500 billion was earned outside the United States. Of this amount, around $ 330 billion has been set aside in just one of the many known tax havens with effective tax rates close to zero: Bermuda, Cayman Islands, Ireland, Luxembourg, the Netherlands, Singapore and Switzerland – and mainly by companies identified only as “non-bank holding companies”.
Tellingly, the Irish government has been one of the few opponents of both the Biden proposals and the Organization for Economic Co-operation and Development side talks, with Finance Minister Paschal Donohoe recently saying that “small countries … must be able to use fiscal policy as a legitimate lever to offset the real, material and persistent advantage enjoyed by large countries. “
The only real limit imposed by the pre-TCJA regime was that companies could not use the money they had saved on taxes for dividends, buyouts, debt service or mergers and acquisitions. This is why they used the foreign profits recorded in their tax haven subsidiaries to buy debt securities from the US Treasury, agencies and companies, thus building up a reserve of liquidity while waiting for the law to change. The cumulative value of these “reinvested” profits from early 1997 – when profit shifting in earnest after Treasury Decision 8697 – through the end of 2017 was worth more than $ 2.2 trillion.
For these companies, TCJA’s biggest result was that they could use their accumulated offshore savings to increase shareholder payments in exchange for paying a modest “transition tax”. In addition, future foreign profits could be distributed directly to shareholders without being taxed.
In the year since the adoption of the TCJA, buyout and dividend spending by U.S. non-financial corporations each increased by about $ 200 billion from the previous four quarters. At the same time, US multinationals have withdrawn around $ 360 billion from their subsidiaries in major tax havens. But that turned out to be a one-time gain, with dividends and buyouts down around 10% in 2019 compared to 2018. Despite the tax changes, companies continued to hold profits in tax havens in 2019. , although at a lower rate than before.
TCJA may not have done much to increase shareholder payouts or change incentives to shift profits, but it has encouraged US companies to relocate their real economic activity overseas. The problem is that the so-called Gilti and FDII provisions of the law penalize American companies for putting intangibles abroad – as many software and pharmaceutical companies do – unless they also move assets. physical investments outside the United States. Unsurprisingly, US imports of pharmaceuticals have skyrocketed since the passage of the TCJA, with most of the increase coming from tax havens like Ireland and Switzerland. Closing the loopholes created by the TCJA would therefore encourage the revival of national drug manufacturing.
There are many reasons to correct the problems of the global corporate tax system. The good news for investors, at least in US-focused companies like
(WFC), is that most of Biden’s proposals would have no impact on their tax bills. In contrast, many leading tech and pharmaceutical companies would face a substantial increase in their tax obligations even if the statutory corporate tax rate in the United States remained unchanged.
Write to Matthew C. Klein at [email protected]