Who wins and loses from tax reform?
Most of the comments on tax reform center on what happens to individuals – the personal exemption, the mortgage interest or medical expense deduction, and so on. That’s understandable: people want to know how different versions will directly affect them. And the bill’s depends on each taxpayer’s personal situation
But the point of the pending legislation is corporate tax reform – to find ways to lower our corporate tax rate. It’s widely understood that this tax hurts American businesses, because our corporate tax rate is now almost the highest in the world. Companies as diverse as Medtronic to Burger King to Johnson Controls have moved their corporate headquarters from Minnesota or Wisconsin to Ireland or somewhere else overseas. And there are other legal ways for global companies reduce their tax bill.
Both the House and Senate version will cut the corporate tax rate significantly, if passed. And this will have a disparate impact on different industries.
Source: Compustat, Goldman Sachs, Hightower Advisors
If corporate taxes are cut to a uniform effective rate of 23%, telecom and energy companies will benefit the most, healthcare and tech companies the least. It’s not hard to see why. The big cellular service providers and oil companies are US based – with domestic customers and domestic operations. We still import, on net, over 4 million barrels of oil per day. But health care and technology companies with broad global operations can shelter their income from taxes. Tech firms last year had an effective tax rate of 19.5%. That’s why firms like Apple and Microsoft have been borrowing money to pay dividends to their domestic shareholders, even though they have billions of dollars in cash on their balance sheets, and generate billions more every month.
Small cap stocks – with mostly domestic operations – also benefit significantly from lower corporate taxes. We’ve seen their market values jump almost 15% lately as the prospects for tax reform have improved.
Photo: Derek Lilly. Source: Morguefile
Hopefully, the tax reform’s true winners will be all of us – investors, workers, taxpayers – as companies invest and grow more rapidly with higher expected returns. But get ready for some changes. That train is coming around the bend.
Douglas R. Tengdin, CFA