“IT’S always a lot of fun when you win,” President Donald Trump enthused after his tax package was approved by Congress in December. Company bosses nodded along. The centrepiece of the reform is a drastic cut to the corporate-tax rate, from 35% to 21%, taking it below the rich-country average. Although its impact is partly offset by some revenue-raising measures, the congressional Joint Committee on Taxation estimates that American business will gain around $330bn from the reform over the next ten years. Yet within that are sizeable variations in terms of which firms and industries benefit most.
The biggest winners are more domestically oriented companies. These typically face higher effective tax rates than American companies with a big presence overseas, which do business in lower-tax countries. Bosses are also evaluating other new measures. So-called “full expensing”, for example, helps those with big spending plans by allowing them to deduct investment costs up front. But using debt will become less attractive, as interest payments are no longer fully deductible.
Some firms experienced high volatility in their earnings for the final quarter of 2017 thanks to the treatment of so-called “deferred tax assets”. These are past tax losses carried forward to set against future tax bills, and such assets have shrunk in value because of the lower corporate-tax rate. Other firms that hold deferred liabilities enjoyed big one-off gains.
Of the 150 S&P-listed companies that have so far released estimates of their effective tax rate for 2018, telecoms and consumer-focused companies (which often have a big American presence) expect to have gained the most, says Ramaswamy Variankaval of J.P. Morgan, an investment bank (see chart). AT&T, a telecoms giant, predicts a rise in cashflow of $3bn in 2018, or nearly a fifth of cashflow last year.
Multinational firms do benefit from a lower American headline tax rate. They will also pay a much lower tax rate, of 15.5%, on foreign cash that is repatriated. Yet while they were previously taxed only when the money was brought home, now they must cough up and pay tax on all of their $3trn stockpile of foreign cash over an eight-year period.
Other changes to the treatment of foreign income are more controversial. The new “base-erosion anti-abuse tax”, or BEAT, applies to all big firms operating in America and targets cross-border payments to foreign affiliates, such as royalties on intellectual property. Firms must now add such services back into their American corporate earnings, and pay a 10% tax (after 2018, until when a 5% rate applies) on this broader base—if it exceeds the standard calculation of 21% on a narrower base. Another new tax charge applies only to American firms that have “global intangible low-taxed income” or GILTI—returns on intangible assets, such as patents or software, parked abroad.
Both BEAT and GILTI were intended to prevent companies from dodging tax by stashing intellectual property and other intangibles in tax havens, notes Jennifer Blouin, from the University of Pennsylvania. But, as drawn up, they are much broader, she says, and could capture all foreign affiliates, even if they already pay high tax rates, such as those in Germany. That has irked some European firms.
With bureaucrats still transcribing the hastily drafted legislation into rules for business, firms cannot yet be sure of their total impact. But many technology and pharmaceutical companies, even though together they hold the most cash abroad, anticipate slightly lower tax rates as a result of the reforms, says Mr Variankaval. Even Apple, which booked a $38bn tax payment on its $250bn mountain of foreign cash (it has yet actually to pay it), expects a net benefit. In contrast, some other firms, such as IBM and General Electric, expect slightly higher tax rates in 2018 than they paid last year, as the wider tax base offsets the lower headline rate.
Unsurprisingly, the reforms appear to negate the benefits of “inversion”, or setting up abroad for tax purposes. Valeant and Allergan, both drugmakers domiciled abroad, expect higher tax rates. It is too early to tell, though, if the tax changes will succeed in shifting supply chains and intangible assets back to America.
It is also too early to gauge how the winners will spend their gains. According to Americans for Tax Reform, a lobbying group, 377 companies have announced pay awards linked to the tax reform, including AT&T and American Airlines. Most are bonuses that amount to a small part of the total gains, leading sceptics to attribute the announcements to clever public relations. A few firms have gone further, announcing permanent wage increases or new investment projects. But these were probably in the pipeline anyway, given improving demand, says Matt Gardner, from the Institute on Taxation and Economic Policy, a think-tank.
That said, most analysts do expect the lower corporate-tax rate to make investing in America more attractive in the longer term. But if the past is any guide, argues Ms Blouin, repatriated earnings will mostly be returned to shareholders. Last week Cisco, a tech company, said that was precisely what it would do with most of the $67bn it was bringing home. Like Mr Trump, investors, too, are in for some fun.
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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