It has been a point of frustration for many of us in the financial industry that corporate tax reform has taken a back seat to “Fed watching” and political sparring. Mediocre U.S. economic growth during this expansion has been blamed on many different factors, the Fed’s policies, demographics, geopolitical issues, post-traumatic stress from the financial crisis, you name it. It is “the new normal”.

Several policies affecting the corporate world that have or have not been put in place since the great recession have left their mark. Regulations, whether good or bad have made the business environment more difficult to navigate (Dodd-Frank, the lapse in the Export Import Bank authority) and to turn a profit. Whichever side of the ObamaCare dispute that you land on, there is little debate that for many companies, it increases the cost of doing business and reduces the incentive for hiring full time workers without substantial visibility of increasing demand. What seems particularly obtuse, however, is the lack of serious deliberations on changing corporate taxation as a means to jump start meaningful economic growth. The U.S. has had the second highest corporate tax rate among developed nations since 2004 according to the Organization for Economic Cooperation and Development (OECD). When Japan lowered its rate, we became #1.

It is apparent that the political dysfunction in Washington has prevented the greatest country in the world (absolutely no bias here), inhabited by some of the most intelligent individuals in the world (also no bias), to create resolution on our outdated tax policies.  This impasse between and within political parties which appears to stem from power games, protectionism and perhaps an insufficient understanding of economic principals has most probably contributed to the low growth environment that we are currently experiencing. It is well documented that tax strategies play a significant role in capital investment decisions by all corporations – how much to spend and where to spend it. Our tax policies regarding foreign and domestic revenues have resulted in the expatriation (tax inversions) of many originally U.S. domiciled corporations during the past ten years or so. Jobs and capital investment have also moved overseas by others that remain here. The response by Washington to strategic business plan decisions initiated by companies to realize higher earnings and enhance shareholder value is to label the actions as “unpatriotic” and propose new regulations. Are smart business practices now unpatriotic – in a capitalist, democratic country? Corporations, like investors, allocate capital with the goal of maximizing returns.

It seems rather evident that the current higher than normal tax rate would result in competitive disadvantages for America, as a country, and our corporations in a global marketplace. Tax consequences are an integral part of the investment decision-making process for corporations and not just U.S. companies, but also foreign companies that may invest in the U.S. As we continue to see declines in recent manufacturing indicators, it seems likely that a change in our tax structure could spur investments and jobs. The recent September Institute of Supply Management (ISM) Manufacturing Index reflected another decline to 50.2 from 51.1. We are very close to contraction for the U.S. manufacturing sector (below 50). Are we currently incentivizing U.S. companies to go abroad and to keep capital offshore? Seems that way, America is the only G-7 country that has worldwide taxes for domestic corporations on profits generated offshore. Of the members of the OECD, the other countries with worldwide trading practices are few in numbers and have a lower top tax rate than the U.S. If American companies are stashing funds away outside our borders to defer taxes, where is it exactly that we trying to promote growth? A territorial tax system, where solely income generated domestically is taxed would likely bring a substantial amount of those funds home.

Questions abound on how the effect of a reduction in revenues for the U.S. coffers would play out on the deficit. In practice, will the lower tax rate and a conversion to a territorial system be offset by revenues from higher economic growth? It is impossible to determine exactly how the numbers will shake out but, what we do know is that a simplified, more competitive tax landscape would place tax inversions (e.g. Eaton Corp., AON, Rowan Cos.) and capital flight in a less attractive light.

With the advent of a new election cycle, we are beginning to see (yet again), presidential candidates’ tax restructuring plans for Individuals and Corporations. Alhambra prefers to remain impartial on the political front, but we encourage our clients and friends to analyze the alternate tax plans as they are released by the candidates. A few are already available, and studies on the potential effects have been/are being quantified by economists.

“THE NATION SHOULD HAVE A TAX SYSTEM THAT LOOKS LIKE SOMEONE DESIGNED IT ON PURPOSE.”

– WILLIAM SIMON, FORMER U.S. TREASURY SECRETARY

 

Margarita V. Fernandez

Vice President – Alhambra Investment Partners, LLC

 “Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Margie Fernandez can be reached at:

MFernandez@4kb.d43.myftpupload.com