In the rankings of winners and losers from the Republican tax bill passing through Congress, US companies are among the biggest beneficiaries. The gains for businesses are unevenly shared out, however: there will be large savings for some, while others pay more.
The tax package also delivers the greatest benefits, for companies as well as for individual taxpayers, in its first few years, blunting its long-term impact. The bigger prize in tax reform, shifting the economy on to a sustainably higher growth path, remains elusive.
The full implications of the bill will take months to become apparent. The final text of the legislation was published only late on Friday afternoon, giving analysts minimal time to assess it. But economists at the Penn Wharton Budget Model at the University of Pennsylvania have published some early estimates of how the package might affect US companies.
Headline-grabbing move
The headline-grabbing move is the cut in the main rate of corporate tax from 35 per cent to 21 per cent. Other changes - in particular a temporary tax break allowing immediate expensing of some capital spending, and restrictions on interest deductibility - will also have a significant impact on the tax rates that companies face.
Immediate expensing for spending on shortlived capital equipment is expected to save US companies $32.5bn in 2018, according to Congress’s joint committee on taxation. By 2027, however, the end of that tax break is expected to cost them about $14bn. A future Congress could always choose to make the tax system more generous, but such concessions cannot be taken for granted.
Taken together, the changes mean that US companies will see a steep drop in their average effective tax rate next year, according to the Penn Wharton model: from 21 per cent if the bill did not pass, down to just 9 per cent. By 2027, though, the effective rate is scheduled to rise back up to 19 per cent.
The industries that are likely to be the largest beneficiaries, relative to the total size of their tax payments, include mining, accommodation and food services, which are able to make use of the allowance for shortlived equipment. Without the bill, the average effective tax rate for the mining industry was expected to be about 16 per cent next year. If the bill passes, that will drop to just 7 per cent, according to the Penn Wharton model.
Debt is key
Another key factor driving differences in the effects of the bill is debt. The limits on interest deductibility will initially have “little impact” on financially robust investment-grade borrowers, according to Standard & Poor’s, the credit rating agency. Lower-rated “junk” borrowers with high debts, however, would see “neutral to negative” effects, the agency warned.
The companies with the highest interest payments relative to their earnings would on average see little to no benefit from the tax package overall, because their losses on interest deductibility would offset some or all of the benefit from lower rates and the tax break for capital spending.
The bill will also have widely varying effects across stock market sectors. Barclays has estimated that 2018 earnings per share will be raised by an average of 6.3 per cent, with the increases ranging from 1 per cent for the real estate sector to 11.9 per cent for the consumer staples sector.
Capital spending
Maneesh Deshpande of Barclays said he expected some “modest” scope for share prices to rise further, because markets had not yet fully anticipated the tax cuts. While the bill has been passing through Congress, there has still been potential for it to be blocked - even if the signals are that it was in the home stretch.
To justify a further jump in valuations, Mr Deshpande said, investors would have to believe that the US economy was now on a faster long-term growth track, and there was as yet little evidence to support that view.
If the tax cuts do stimulate a surge in capital spending, it would raise hopes that such a structural improvement in growth rates is possible. However there is widespread scepticism among analysts about whether boards will decide to spend their tax windfalls in that way.
Howard Silverblatt, senior industry analyst for S&P Dow Jones Indices, said companies were more likely to focus on returning cash to investors through share buybacks.
“Companies have a record amount of cash, and access to capital is cheap,” he said. “If a company was really able to invest in a new plant and make more money, why hasn’t it already done it?”
– Copyright The Financial Times Limited 2017
