LONDON (Reuters) – Global investors are obsessed with borrowing costs, discount rates, and inflation risks as the world emerges from the shocking pandemic – but they’re also starting to think about upcoming corporate tax hikes that could reverse a decade-long decline.
FILE PHOTO: A woman holds a sign promoting corporate taxation during a protest outside the Amazon to demand that the city of Seattle tax the largest corporations to fund affordable housing, according to organizers in Seattle, Washington , USA, April 10, 2018. REUTERS / Lindsey Wasson
Few governments struggling to vaccinate populations and reopen economies are still likely to raid businesses. Many are still offering tax breaks or loans as rising government debt closes the income gap, as well as funding public subsidies and new spending incentives.
But as the UK showed last week with a planned 7 percentage point rise in corporate tax to 25% in 2023, the tax official is coming.
Although no schedule is set, US President Joe Biden has promised to at least partially reverse the business tax cuts made by predecessor Donald Trump and raise corporate tax by 7 points to 28%. Biden has also re-energized plans to tax global digital and e-commerce giants, most of which have benefited disproportionately from pandemic lockdowns.
At a G20 meeting two weeks ago, Treasury Secretary Janet Yellen dropped a Trump administration proposal to phase out large corporations in hopes of a summer deadline for nearly 140 countries to change outdated rules on taxing cross-border trade and a global minimum company to modernize tax rate.
If a greener, more equitable, and more indebted world is the legacy of COVID, as many investors claim, then higher corporate taxes that have been falling for decades should also be part of that mix.
The average corporate tax rate in industrialized countries is only two thirds of what it was 20 years ago. The share of national debt in production in advanced economies has increased by more than 50% over the same period.
According to the Organization for Economic Co-operation and Development, the total U.S. tax on corporate profits in 2019 was less than 1% of gross domestic product and less than 4% of all taxes – both the lowest in at least 55 years and the lowest in the G20. The UK’s corresponding statistics were the lowest in 25 years.
Barclays analysts estimate that the median effective corporate tax rates for FTSE 350 companies in the UK and S&P 500 companies across the Atlantic were 19% and 20% respectively – below the OECD average of 22% and 5 percentage points below the euro zone average.
“After years of business-friendly policies and falling corporate tax rates, the trend could soon be reversed,” wrote Emmanuel Cau’s equity strategy team at Barclays, citing the tax as a medium-term threat to earnings.
Chart: OECD chart on corporate income tax as% of GDP –
Cau estimates that the corporate tax hike in 2023 will pose a headwind of around 6% for the majority of domestically exposed UK public companies. Higher-income FTSE100 overseas companies – where the “effective” tax rates, taking into account different incomes, deductions and allowances, were already 23% – would likely get a lower hit of 3%.
While a “super deduction” between now and March 2023 will ease effective tax rates in the short term, it will not overlap with the higher base rate when it comes, and the latter may need to be factored in one-to-one.
The Berenberg economist Kallum Pickering asked whether the tax increase will ever come into play in the politics of Brexit and the re-election of the conservative party. If so, however, he would expect effective tax rates to rise more than the lead reductions over the past 20 years, and they could hurt an otherwise significant post-pandemic investment and productivity.
“It is a historical irony that the UK government opted for a more continental economic policy after leaving the EU,” he said.
Barclays’ Cau said a US corporation tax hike could take longer but would likely have an earnings impact similar to that estimated for UK companies. He supported this, citing the 10% earnings improvements that immediately followed Trump’s 8-point tax cut in January 2018 – little more than a one-to-one relationship.
Of course, different sectors will get different hits – not least because of the different effective tax rates. The relative weight of certain sectors in different economies explains in part the differences in overall taxation.
IT and healthcare companies have the lowest effective rates below 20%, while energy and industry are among the highest. Because of this, tax hikes can encourage the prevailing rotation of equity investment from growth to depletion of real economy stocks as the recovery matures.
With the stock markets back to record highs overall, investors hardly seem concerned about the upcoming taxes. Massive government support and capital expenditures as well as historically still super cheap loan rates help.
But perhaps the lack of market fear – even the acceptance of new priorities and norms after the pandemic – only underscores an inevitable reversal of 40 year business tax cuts.
Graphic: Barclays charts showing declining corporate taxes over decades and effective tax rates –
Graphic: Barclays Chart of UK Corporate Tax Plans –
by Mike Dolan, Twitter: @reutersMikeD; Adaptation by Alexandra Hudson