Here’s What Biden’s Corporate Tax Plan Means for Investors - Barron's

President Biden, shown Wednesday before Congress, wants raise corporate taxes and curb incentives for U.S.-based companies to keep profits overseas.

Doug Mills/Pool/Getty Images

Multinationals may soon be forced to pay a higher share of their profits to the governments of the countries where they operate. “We’re going to reform corporate taxes so they pay their fair share,” President Biden said Wednesday in his address to Congress.

Biden’s “Made in America Tax Plan” would raise the statutory federal rate to 28% from 21%, remove incentives to relocate profits and production to tax havens, and impose a 15% minimum tax on businesses that report high profits to investors but little to no taxable income to the Internal Revenue Service. It would mark a major step toward an international agreement to limit tax avoidance that’s been endorsed by finance ministers of many U.S. allies and would end what Treasury Secretary Janet Yellen recently called the “30-year race to the bottom on corporate tax rates.”

Businesses that generate most of their value from intangible assets such as software and pharmaceutical patents—and have therefore had the easiest time shifting profits to avoid the IRS—would be hit hardest. Other sectors that have had less success shielding their profits from taxes, such as telecoms, retailers, and banks, could stand to benefit on a relative basis. In fact, they might not lose out at all, especially if the proposed increase in the headline tax rate is whittled down to 25% or less to protect other provisions.

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Consider that America’s most tax-efficient companies faced effective rates below the current 21% even before the passage of the Tax Cuts and Jobs Act, or TCJA, at the end of 2017. According to a Barron’s analysis of company filings, Alphabet (ticker: GOOGL), Apple (AAPL), Johnson & Johnson (JNJ), and Microsoft (MSFT) are among U.S. multinationals that had effective tax rates of about 19% in the years before TCJA.

The biggest reason, which all of the companies clearly explain in their annual securities filings, is that they were able to shift much of their reported earnings to jurisdictions where corporate profits are lightly taxed—if they are taxed at all. TCJA didn’t alter this basic dynamic, which is why it reduced these companies’ yearly tax burden only by roughly four percentage points.

Biden’s plan would have a sizable impact on those companies, even if the federal statutory rate remained constant at 21%, because it would ensure that all profits earned abroad would be taxed at least 21%. If a foreign government had a corporate tax rate at 21% or higher, the IRS would collect nothing, but any subsidiary in a jurisdiction where the tax rate is below 21% would have to pay the difference to the IRS.

Of the roughly $2.2 trillion in corporate profits earned by American businesses in 2019, more than $500 billion was earned outside the U.S. Of that, about $330 billion was booked in just one of several known corporate tax havens with effective tax rates near zero—Bermuda, the Cayman Islands, Ireland, Luxembourg, the Netherlands, Singapore, and Switzerland—and mostly by businesses identified only as “nonbank holding companies.”

Tellingly, the Irish government has been one of the few vocal opponents of both the Biden proposals and the parallel Organization for Economic Cooperation and Development talks, with Finance Minister Paschal Donohoe recently saying that “small countries…need to be able to use tax policy as a legitimate lever to compensate for the real, material and persistent advantage enjoyed by larger countries.”

The only real limit imposed by the pre-TCJA regime was that companies couldn’t use the money they saved on taxes for dividends, buybacks, debt service, or mergers and acquisitions. That’s why they used the foreign profits booked in their tax haven subsidiaries to buy U.S. Treasury, agency, and corporate debt securities—building up a cash hoard while they waited for the law to change. The cumulative value of these “reinvested” earnings from the beginning of 1997—when profit-shifting began in earnest after Treasury Decision 8697—through the end of 2017 was worth more than $2.2 trillion.

For these companies, the biggest upshot of TCJA was that they could use their accumulated offshore savings to lift shareholder payouts in exchange for paying a modest one-time “transition tax.” Moreover, future foreign profits could be distributed directly to shareholders without being taxed.

In the year after TCJA was passed, spending on buybacks and dividends by U.S. nonfinancial companies each rose by about $200 billion compared with the preceding four quarters. At the same time, U.S. multinationals pulled about $360 billion out of their subsidiaries in the main tax havens. But this proved to be a one-off gain, with dividends and buybacks down about 10% in 2019 from 2018. Despite the tax changes, companies kept retaining earnings in tax havens in 2019, albeit at a lower rate than before.

TCJA may not have done much to boost shareholder payouts or alter the incentives to shift profits, but it has encouraged U.S. companies to relocate real economic activity abroad. The problem is that the law’s so-called Gilti and FDII provisions penalize American businesses for putting intangible assets offshore—as many software and pharmaceutical companies do—unless they also move physical investments outside the U.S. as well. Unsurprisingly, U.S. imports of pharmaceuticals have soared since the passage of TCJA, with most of the increase attributable to tax havens such as Ireland and Switzerland. Closing the loopholes created by TCJA would therefore encourage the revival of domestic drug manufacturing.

There are many reasons to fix glitches in the global corporate tax regime. The good news for investors, at least in U.S.-focused companies such as Comcast (CMCSA), Target (TGT), and Wells Fargo (WFC), is that most of the Biden proposal would have zero impact on their tax bills. By contrast, many leading tech and pharma companies would face a substantial increase in their tax obligations, even if America’s statutory corporate tax rate remained unchanged.

Write to Matthew C. Klein at matthew.klein@barrons.com

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