David Rosenberg: Elevating funds to help pandemic spending is vital, however company tax hikes can be a breeze

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David Rosenberg: Raising funds to support pandemic spending is critical, but corporate tax hikes would be a breeze

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Not only would they not pay a lot, but they would also hurt America’s competitiveness by making it the highest tax sovereignty in the OECD

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David Rosenberg The administration of US President Joe Biden has proposed that the corporate income tax law be amended to raise $ 2 trillion over 15 years to cover the cost of the infrastructure package.The administration of US President Joe Biden has proposed that the corporate income tax law be amended to raise $ 2 trillion over 15 years to cover the cost of the infrastructure package. Photo by Andrew Harnik-Pool / Getty Images

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By David Rosenberg and Ellen Cooper

It’s really a no-brainer for President Joe Biden’s administration to play with the corporate tax rate to fund his massive infrastructure proposal. Efforts to slow the “race to the bottom” in tax policy internationally are laudable, but there is a risk that the proposed tax increases will make the US less competitive and reduce incentives to hire and invest. Even if the damage isn’t too great, these tax hikes are unlikely to bring in much revenue.

It helps understand where things were before the 2017 Tax Cut and Jobs Act (TCJA) was passed. At 35 percent, the U.S. corporate tax rate was well above the Organization for Economic Cooperation and Development’s average of 24.2 percent. Equally important was the unique lack of repatriated foreign business income exemption: US multinationals held billions of foreign profits offshore.

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President George W. Bush was on temporary repatriation leave, but what it took to normalize their system was a general exception like the one we see in Canada and Europe. With this incentive structure, there has been a wave of “inversions” where a non-US foreign parent is sandwiched between the (former) US parent and shareholders. This posed a tremendous threat to the US tax base. It needed to be addressed, through Donald Trump’s tax reform legislation, which introduced a general US tax exemption on repatriation of foreign business income.

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Now the finance department has proposed that the corporate income tax law be amended to raise $ 2 trillion over 15 years to cover the cost of the infrastructure package.

It’s important to remember that corporate income tax makes a relatively small contribution to business results – maybe five to 10% at most

Finding responsible ways to increase income in support of all recent expenses is vital. The problem with tinkering with corporate taxes, however, is that companies embarking on multi-year projects create uncertainty. What company is going to start a multi-year, large-scale spending project without knowing what the after-tax return on invested capital will look like?

In addition, the proposal in its current form would raise the US combined corporate tax rate from 25.8 percent to 32.3 percent, positioning the country as the highest tax sovereignty among OECD countries and reducing US competitiveness. The impact could be a short-term freeze on capital spending, especially as companies hold back during the months of negotiation that will undoubtedly occur as G20 countries work towards a harmonized tax plan.

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We know that after Trump’s tax cuts, investment increased 8 percent year-over-year in 2018, one of the best years of the past cycle for capital deepening. Reversing the cuts could have the opposite effect. However, the effects of the TCJA were temporary (many tax planners already knew by then that the corporate rate of 21 percent was unsustainable), and investments fell to just two percent the following year, even before the pandemic broke out in part of the windfall including share buybacks, which temporarily rose to a high of $ 223 billion for the S&P 500 in the fourth quarter of 2018, up from $ 137 billion in the fourth quarter of 2017.

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The previous tax changes may not have sparked a long-term cycle of capital deepening, but what matters here is the uncertainty, especially if Biden is a one-year president and the US makes another dramatic tax change in just four short years.

There is still some negotiation to be made even within the Democratic Party, but the Treasury Department’s estimate to raise $ 2 trillion from the final reform package seems far-fetched and, of course, influenced by unknown behavior. It’s also important to remember that corporate income tax makes a relatively small contribution to business results – maybe five to 10 percent at most. History shows that it is very stable regardless of the rate and base. There’s no way the corporate tax changes mean much to infrastructure.

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How should the US pay for its infrastructure plan? We do not prescribe policy advice, but it seems that the country needs to have a debate on overhauling the tax system so as not to distort incentives for work and investment. This could mean introducing a VAT or some sort of tax system on goods and services, as is the case in many other countries. This could gradually increase revenues (with generous loans for low-income households) and hardly distort investment decisions. However, the political price would likely be too high. In Canada, implementing a GST was a wise decision, but it came at the expense of the popularity of Brian Mulroney’s Conservative Party. There are also usage fees, public-private partnerships, carbon taxes, etc. that have a place but wouldn’t move the revenue needle as far as it takes to fund the intended spending.

Bottom line: The proposed corporate tax changes are unlikely to do too much damage, but the rates ultimately passed will be well below those of the current plan and are unlikely to generate significant revenue either.

Visit me for my webcast with Dave on May 19th as I meet my longtime mentor and legendary market strategist, Don Coxe. Find out more on my website: rosenbergresearch.com.

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