President Trump’s tax reform plan was released on April 26, 2017, and despite coming with the subtitle “The Biggest Individual and Business Tax Cut in American History” it was a succinct one-page list of bullet points. While we should expect more details in the coming weeks as draft legislation hits the House floor by the end of August, the one-page list and the subtitle gave us some clues on the general direction of the reform: huge tax cuts.
The cornerstone of the tax reform plan is cutting the federal corporate tax rates from 35%, the second highest among the OECD countries, to 15%. The stated policy objective behind this cut, and other disclosed aspects of the reform, is to encourage US multinationals to repatriate to the US cash and income that is currently sitting offshore. This, in turn, is expected to lead to higher investment, faster productivity growth, higher job growth and an increase in wages that would improve the standard of living for the American workers.
But what should we really expect to happen with a 20% decrease in the US corporate tax rates and the resulting repatriation of funds to the country? Here are my seven predictions.
#1 – Decrease in tax revenues
According to the highest estimates, the US multinationals are hoarding $2.6 trillion in cash in low-tax jurisdictions overseas. While a large portion of it is intended for reinvestment, US multinationals do routinely repatriate some amounts back and pay corporate taxes in the US on the difference between the 35% US corporate tax rate and the lower tax rate paid elsewhere. A 15% US corporate tax rate will be lower than corporate tax rates in most countries not considered tax havens.
The US multinationals are likely to accelerate repatriation of excess funds to the country with the tax reform, and may not pay much more in taxes than they have already paid elsewhere, resulting in a minimal immediate corporate tax revenue bump for the US. What’s worse is that majority of the funds being repatriated are likely to have been repatriated over time anyway, and that means the US will lose out on significant corporate tax revenues on these repatriations in the future years.
#2 – Decrease in corporate borrowing
Once the US multinationals repatriate to the US more cash in short-term than they had planned to otherwise, they will be looking to put those funds to good use. One such use would be to pay down corporate debt.
In addition, while the one-page plan didn’t comment on interest deductibility, earlier Trump and Republican tax reform proposals included doing away with the deductibility of interest expense. Not being able to deduct interest expense makes debt on the balance sheet far less attractive and would result in sharp declines in corporate debt issuances.
#3 – Increased share buybacks
When you are flush with cash and don’t have much debt on the balance sheet, share buybacks become an attractive proposition. So expect US multinationals to do just that with the newly freed up excess cash. Share buybacks result in increases in stock prices and create a “wealth effect” where increases in the stock market are found to be positively correlated with consumer confidence, consumption and major purchases.
#4 – Increased M&A activity and consolidation
Another result of recently freed up excess cash will be a sharp increase in mergers and acquisitions (M&A). A large number of US multinationals that are alleged to be sitting on vast sums of cash overseas are in the tech and pharma sectors. The two sectors are already seeing a fair bit of consolidation; sudden access to additional cash should only increase the pace of such activity.
#5 – Greater investment in productivity improvement
The additional cash will be used for investments into productivity improvements that will give US multinationals sustainable cost advantage over their competitors. That means an acceleration in the pace of development and commercialization of artificial intelligence (AI) and machine learning (ML) aided process redesigns and increases in process automation.
#6 – Reduction in domestic jobs created by US multinationals
While the US tax reform is billed as a major job creation initiative by the Trump administration, it may actually reduce the number of jobs created by US multinationals domestically. Increased M&A activity and consolidation results in operational efficiencies such as reduction in headcount and elimination of duplicate facilities.
The Fourth Industrial Revolution, spawned by automation resulting from greater R&D investments, will also result in low-skill, low-wage jobs disappearing.
#7 – Increased inflow of foreign investment
Recent academic studies show that one percent drop in corporate tax rates results in anywhere from two to three percent increase in foreign investment inflows. A 20 percent decrease in US corporate tax rates means the largest developed market in the world becomes much more attractive for foreign multinationals looking to do business in the Americas.
European and Asian multinationals that might have chosen to manufacture in their home countries and ship to the US, or set up manufacturing facilities in Canada and Mexico instead, would find the cost-benefit equation in favour of setting up in the US more agreeable. Greater investments in R&D by the US multinationals will also support the knowledge-based economy infrastructure and the continued development of key talent that is sure to attract foreign multinationals to the country.
Disclaimer: The views outlined here are my personal views and do not necessarily represent the views of any organization that I am affiliated with.
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