Earlier this week President Obama unveiled his budget for 2016. The proposal calls for $3.99 trillion in spending -- about a 6.4% increase from the current year. Revenue collection for the year is estimated to be $3.53 trillion, resulting in a budget deficit of about $474 billion. If approved, it would mark the smallest budget deficit since 2008.
Some of the top-line proposals in Obama's initial proposal could gain traction if Congress and the President see eye-to-eye. For example, Obama's proposal to boost military spending by 4.5% to $612 billion will likely be welcomed to some degree by the Republican-led Congress, which has been pushing for increased military spending for some time.
However, other aspects of the President's budget are likely to be met with staunch resistance, such as any attempt to hike taxes while boosting government spending. In particular, there's one piece of the puzzle in Obama's budget proposal that I suspect will not only be opposed by Republicans in Congress, but could potentially deal a crippling blow to America's senior citizens.
Obama targets overseas corporate earnings
One component of President Obama's 10-year proposal to boost revenue is to tax U.S. multinationals' overseas earnings. This would involve a one-time 14% tax on the estimated $2.1 trillion in corporate earnings currently being held overseas, as well as a minimum 19% tax on future foreign earnings. Overall, the plan is expected to generate $238 billion immediately and $565 billion over a 10-year period.
Why go after corporate profits overseas, you wonder? Simple: The president and Congress need to find a way to address a budget shortfall in the U.S. Highway Trust Fund, which will be insolvent by May of this year if nothing is done. The Highway Trust Fund is funded by diesel and gasoline excise taxes, and it has been paying out more than it's been bringing in for quite some time. It provides aid to states and cities in the form of federal money to be used for construction, reconstruction, and mass transit projects. To be clear, the Highway Trust could remain solvent if the annual benefit paid to states and cities were reduced.
In other words, the new budget proposal wants to tax overseas corporate profits and use that revenue to help pay for infrastructure upgrades around the country.
Additionally, the proposal calls for a reduction in the corporate tax rate to 28% from 35%, with manufacturers getting an even greater reduction to 25%.
The benefits of Obama's proposal
As with all budget proposals, there are positive and negative aspects. The idea of taxing overseas profits is no different.
For instance, using revenue from corporate earnings overseas would allow the U.S. Highway Trust Fund to stay solvent, meaning monthly payouts to states and locales (which total around $1 billion per week) would remain unchanged. That's a big plus, as infrastructure accounts for 14.2 million jobs in this country, according to research firm Brookings -- in other words, about one in every 10 jobs is infrastructure-based. Ensuring that the money keeps flowing from this fund to individual states and cities should help employment levels stay steady in this sector.
Additionally, government spending on infrastructure could provide a boost to the U.S. economy. It's possible a surge in infrastructure improvements, such as road and bridge repair, could lead to new hiring, better pay, and possibly even a boost in consumer spending, the most vital component to U.S. GDP growth.
The move would also put U.S. companies on a slightly more level playing field with U.S. multinationals that choose not to repatriate their profits. Obama's proposal to tax current overseas profits being held outside the U.S. at 14% is a major tax break for corporations looking to bring money home. The normal repatriation tax rate is 35%!
This could also be a bad idea
But, Obama's overseas tax proposal has a number of potential flaws as well.
For starters, it could punish corporate innovation made overseas. In many instances it's not as if large multinational companies are simply stockpiling money in vaults and twiddling their thumbs. These companies are building factories in overseas markets, investing in an overseas workforce and in training, and working toward making their product affordable on a global basis. Taxing those profits could make it difficult for multinationals to raise the 14% upfront tax, especially if it's tied up in overseas investments. This could simply mean U.S. companies may use cash flow in the U.S. to pay the tax, possibly crippling investments in the U.S. by multinationals.
Furthermore, the tax could actually increase the incentive for U.S. multinationals to move more of their profits overseas. Current tax rules call for multinationals to pay the difference between the foreign tax rate and the current tax rate. Because of Obama's proposal to set the overseas tax rate at 19% in the future it'd mean little or no tax liability in nearly all overseas industrialized countries! That's only going to encourage U.S. companies to look overseas for profits, further hurting investment in the U.S.
This could be bad news for senior citizens
Yet, the real kicker is what this tax hike could do to America's retirees.
Remember, America's seniors are all about capital preservation and safe income creation. This means they're not investing in the next Facebook (NASDAQ:FB). Instead, they're buying global businesses that have a tenured history, solid brand-name, steady cash flow, and which generate a sizable and growing dividend.
Within the S&P 500, about half of all profits come from overseas markets. This includes $110 billion in overseas profits for General Electric (NYSE:GE), $69 billion for drug giant Pfizer (NYSE:PFE), and $54 billion for tech king Apple (NASDAQ:AAPL) per The Wall Street Journal and Audit Analytics. Per Bloomberg another $92.9 billion is held overseas by Microsoft (NASDAQ:MSFT). Higher taxation means one thing for these and other blue chips: less profits and the possibility of fewer shareholder incentives, including dividends.
Think about this: Based on Bloomberg's estimates S&P 500 companies spent 95% of their $964 billion in corporate profits on shareholder incentives in 2014. This includes $565 billion in share buybacks and $349 billion in dividends. In short, companies are already paying out a substantial amount of their profits to investors. Now, imagine what would happen if $238 billion were immediately due in taxes. My guess is dividend payments could be the first to see a reduction since share buybacks help reduce the number of shares outstanding and can improve a company's valuation. Either way, it could be a crippling blow to seniors who've come to depend on low-volatility and moderate-to-high-yield blue chips for income generation.
Plenty to be decided
If there is some potential solace for seniors here, it's that initial budget proposals are just a starting point for negotiations, so it's very possible we could see some wiggle room to these tax rates if this particular aspect is approved.
Also, it's not as if other proposals for reining in overseas corporate profits aren't on the table. A temporary lowering of repatriation taxes has been proposed and enacted before under President George W. Bush in 2004. It did generate a decent amount of income for the government, but it never wound up being the economic boost that it was expected to be.
Another option could be waiving the repatriation tax altogether which could lead to huge increases in domestic investment, but at the cost of leaving the federal government short of tax revenue and still in a deficit.
Regardless of which side of the political aisle you sit on, as an investor this debate promises to be a hot button issue over the next few weeks or months to come. I'd suggest paying close attention to the debates leading up to the final product as it could eventually have an impact on your portfolio and especially the income of America's senior citizens.