In less than two weeks' time, the unlikeliest of all candidates when the presidential campaigning began -- Donald Trump, a man with no prior political or military experience -- is set to be sworn in as the 45th President of the United States. Republicans also maintained a majority in both houses of Congress, so they will be in control of both legislative and executive branches of government for the first time since early 2007.
Shortly following his victory on Election Day, Trump and his team released a 100-day action plan littered with objectives ranging from infrastructure spending plans, to repealing and replacing Obamacare, to individual and corporate tax reform. Out of the dozens of changes on Trump's plate early in his presidency, none may be considered more important to economic growth than corporate income-tax reform.
Trump's corporate tax reforms, in a nutshell
Right now the United States has the third-highest marginal corporate income tax rate in the world, behind only Puerto Rico (which has independent tax-levying authority under U.S. law) and the United Arab Emirates. When you tack on state and local taxes, companies can sometimes be on the line for a peak marginal rate of 39.6%. It's Trump's contention, and that of many Republicans, that paying too much in federal taxes is hampering the growth prospects of American businesses and discouraging foreign investment in the United States.
Trump's corporate income-tax reform proposal takes two forms. First, he wants to drop the corporate income tax rate from 35% to just 15%. According to a statistical analysis of Trump's entire tax plan by the Tax Foundation in September, lowering the corporate income tax rate to 15% is expected to result in a more than $1 trillion decline in federal revenue over the next decade. That's more than 25% of the $3.93 trillion in reduced revenue predicted by the Tax Foundation's dynamic model over the next decade. However, lowering the corporate tax rate to 15% from 35% would also boost U.S. GDP by 4.1% over the decade, comprising half of the expected 8.2% positive GDP growth estimated by the Tax Foundation's model.
The second component of Trump's corporate tax reform includes creating a tax-holiday rate of 10% to allow U.S. multinationals to repatriate the nearly $2.5 trillion in profits currently being held overseas. The idea here is that if U.S. companies could bring home billions of dollars, they'd be able to put that money to work in hiring, innovation, and business expansion.
One of the reasons why the stock market has had such a voracious end-of-year rally may be the expectation that these corporate tax reforms will lend to bigger profits and juicier growth prospects in the years that lie ahead.
But, what if Trump's corporate tax reforms fall flat? Believe it or not, there's a really good chance that could happen.
These proposed corporate tax reforms have big-league problems
Though there's always the possibility that corporate tax reforms lead to an increase in employment and business reinvestment, there are three particular ways Trump's corporate tax reforms could fail to achieve their objective.
To begin with, just as Trump's individual income-tax reforms have been criticized for disproportionately helping the rich as opposed to middle- and lower-income classes, his corporate income-tax reform won't be providing much assistance to a number of small businesses. Certain types of pass-through firms, such as partnerships, limited-liability companies, and sole proprietorships, are still in line to be hit by the individual peak marginal tax bracket of 33% as opposed to the peak corporate income tax rate of 15%. This would be a major blow to what's often referred to as the backbone of the American economy, and it could mean that Trump has overestimated the growth potential of his corporate tax reforms.
But don't worry, big corporations could get hit as well. Despite Trump's plan to offer a tax repatriation holiday on the nearly $2.5 trillion held overseas, his tax plan does nothing to address the problem of double taxation on foreign profits once U.S. multinationals have repatriated their initial capital. In short, U.S. multinationals operating in overseas markets are already paying tax in the country or countries they're operating in. Yet, they could still be required to pay the peak marginal corporate income tax rate of 15% in the United States, effectively minimizing any benefit of reducing the corporate tax rate domestically.
But the biggest issue of all is that Trump's corporate tax repatriation plan cannot control the will of corporations. In other words, Trump can't dictate what companies do with the nearly $2.5 trillion in cash being held overseas, even if he'd like to.
For instance, the last time there was a corporate tax repatriation holiday in the U.S., and stock buybacks were disallowed, it was discovered years later that businesses still managed to use a substantial amount of their repatriated funds for stock buybacks. Stock buybacks reduce the number of shares outstanding and can have a positive impact on earnings per share, potentially lifting a stock's share price. What they don't do is create jobs.
A December survey by the CNBC Global CFO Council found that just 12.5% of surveyed U.S. CFOs planned to use repatriated capital to increase headcount. By comparison, there was higher conviction from CFOs with regard to using repatriated capital for mergers and acquisitions, new buildings or equipment, and research and development. An increase in R&D or new buildings could be construed as a positive, but M&A isn't necessarily good news for the labor force since it often means the elimination of job redundancies, not hiring. Once again, the actual impact on jobs and GDP growth of Trump's corporate tax reforms may have been overestimated.
Obviously, no one knows for certain whether Trump's corporate tax policies will fail or succeed, or if they'll even be passed into law based on their current outline. We need time to figure that out. But based on a number of clear deficiencies, Trump's corporate tax reforms may not have anywhere near their desired effect.