One Year Later: The Impact of the Tax Cuts and Jobs Act
We are just beginning to see the economic effect of the TCJA, passed in December 2017, but tax cuts are among many factors influencing U.S. investment decisions.
Corporate Income Tax Rate
Perhaps the most publicized component of the bill involves the cut of the federal corporate income tax rate to a flat 21 percent. Previously, the U.S. corporate income tax was broken up into four brackets depending on income, with rates of up to 35 percent for large companies.
As the Congressional Budget Office reported in 2017, this rate was the highest statutory corporate income tax rate and the fourth-highest effective tax rate among G20 countries. Of course, lower corporate income tax rates that increase returns on investment make a location more attractive. In fact, the TCJA’s rate aligns the U.S. more closely with neighboring Canada (26.5 percent, Ontario; 26.7 percent, Quebec), which is perhaps the closest comparison. The tax rate reduction increases after-tax earnings on U.S. investments and, as a result, should marginally influence site selection decisions.
Territorial Tax System
Another important change with TCJA is the shift to a territorial tax system. This means U.S.-based multinational corporations now pay income taxes only against U.S. earnings — as opposed to a corporate tax on worldwide earnings. Like the corporate tax rate, this alteration makes the country more competitive with other developed nations.
Before the TCJA, several U.S.-based multinationals began implementing a tax strategy called a “corporate inversion,” whereby the multinational’s parent company would be domiciled outside of the U.S. to avoid the worldwide tax system. This was temporarily halted by the Obama administration, but similar avoidance strategies continued because of the worldwide system. The territorial switch should minimize the need for some avoidance strategies, resulting in more efficient capital flows back to the U.S.
However, a provision in the TCJA could diminish the competitiveness gains of the switch to a territorial tax system. Called the Base Erosion and Anti-Abuse Tax, “BEAT” is a mechanism whereby U.S. and foreign-resident corporations cannot reduce their U.S. profits (via payments to parties in low-tax countries) without facing a minimum tax of 10 percent (12.5 percent after 2025).
The tax affects businesses where U.S. gross receipts are more than $500 million.
Under the TCJA, U.S. multinational corporations that previously deferred foreign earnings will now pay 15.5 percent for cash and cash-equivalent assets and 8 percent for non-cash assets — down from a full 35 percent on the former tax code.
The prior system allowed multinationals to stockpile foreign earnings offshore for years and defer paying the full U.S. tax, thus deterring foreign capital flows back to the U.S. Companies were incentivized to only bring back as much income as could be offset by foreign tax credits or as economically necessary. The new tax rate may prompt a return of this foreign earnings cache, thereby encouraging multinationals to invest in the U.S.
Among S&P 500 firms, approximately $2.8 trillion in foreign earnings had been deferred, which meant less capital for U.S. parent companies for domestic investments, and less wages paid to U.S. workers. With the offshore earnings expected to be repatriated, an estimated $339 billion in new federal corporate income taxes is expected to be collected over the next decade.
TCJA In Action
Approaching one year after its signing, the TCJA has wavered somewhat in its public approval, but it has potentially prompted capital expenditure projects and returned a focus to employee wages and bonuses.
From a site selection standpoint, the bill increased U.S. competitiveness. This is apparent in companies (such as AT&T, Home Depot, Apple, JetBlue, and Walmart) announcing new bonuses for employees at an average of $1,000, in addition to salary increases, while citing the TCJA as having an impact. The reform’s effects are also being realized in capital investments. Several companies have announced multi-billion-dollar projects (e.g., Apple, Pfizer, and ExxonMobil).
However, the TCJA does not stipulate how increased after-tax earnings must be allocated and, as such, some economists have highlighted the ambiguity — effectively questioning the TCJA’s impact. It is also likely that due to the reform, after-tax earnings may go to company stock buybacks, dividend payouts, and executive bonuses. In fact, Barron’s recently reported that companies in the S&P 500 spent $646 billion in share buybacks in the 12 months through June 2018.
What We’ve Seen
Despite these rather sweeping changes with the TCJA, U.S. site selection competitiveness also hinges upon factors related to volatility and even government spending.
Approaching one year after its signing, the TCJA has wavered somewhat in its public approval, but it has potentially prompted capital expenditure projects and returned a focus to employee wages and bonuses. In September, The Wall Street Journal cited a Goldman Sachs analysis suggesting that buybacks accounted for the largest percentage of cash spending by companies for the first time in 10 years,calling into question the TCJA’s impact on new jobs and investment from the repatriated foreign earnings. This may be a cautionary sign as, historically, companies used the most cash on capital expenditures (factories, equipment, and other goods), the WSJ noted. This could mean the market strength may not be a good litmus test of stability if funds are not flowing through the inner-workings of U.S. companies.
Federal spending trends could also catalyze more challenges. As NPR notes, the federal deficit skyrocketed to $779 billion in the recent fiscal year.The federal government is expected to borrow more than a trillion dollars in the coming year, in part to make up for lower tax receipts because of the TCJA. The result is more taxpayer dollars spent on debt-financing costs and less on government investments in R&D, education, domestic goods/services, or returning more money to taxpayers.
While White House Budget Director Mick Mulvaney said that accelerating economic growth will eventually fill the deficit hole, increased spending and potential friction in the market could raise red flags for foreign direct investment and business expansion.
Despite the shifts in the tax code — a step in the right direction — the only proven and economically efficient tax structure for attracting capital and investment from multinational corporations is a low-rate, broad-base system. The TCJA’s impact remains uncertain, as avoidance strategies still, and always will, exist. The TCJA may simply be the latest strike in the endless “whack-a-mole” approach to corporate taxation.
Changes in the Incentives Landscape
Supply Chain Bottlenecks Creating New “Logistical Hotspots”
Front Line: Finding, Creating, and Supporting Talent
The “Great Resignation” Is Impacting Corporate Relocations
Workforce Q4 2021
Communicating Your Project’s Value to Local Stakeholders
The Challenges of Renovating an Existing Facility Into a Food Plant