Corporate Tax

Company earnings tax will rise worldwide

Corporate tax hikes are expected that will reverse the decade-long decline.

Few governments struggling to vaccinate populations and reopen economies are 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 increase in corporate tax to 25 percent in 2023, the tax official is coming.

Although no schedule has been set, US President Joe Biden has promised to at least partially reverse the business tax cuts made by predecessor Donald Trump and to raise corporate tax by 7 points to 28 percent. 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proposal to phase out large corporations in hopes of a summer deadline for nearly 140 countries to review outdated rules on taxing cross-border trade and a global minimum company to modernize tax rate.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 percent over the same period.

According to the Organization for Economic Cooperation and Development, the total U.S. tax on corporate profits in 2019 was less than 1 percent of gross domestic product and less than 4 percent of all taxes – both the lowest in at least 55 years and the lowest in the G20. The corresponding UK statistics were the lowest in 25 years.

Barclays analysts estimate the median effective corporate tax rates for FTSE 350 companies in the UK and S&P 500 companies across the Atlantic to be 19% and 20%, respectively – below the OECD average of 22% and 5 percentage points below the OECD average Eurozone 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.

Cau estimates that the UK corporation tax hike in 2023 will represent a headwind of around 6 percent for the majority of domestically exposed UK companies. Higher-income FTSE100 overseas companies – where the “effective” tax rates, which take into account different incomes, deductions, and allowances, were already 23 percent – would likely get a lower hit of 3 percent.

Although 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-on-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 assume that effective tax rates would increase more than the lead reductions over the past 20 years, and they could entail otherwise significant investment and productivity post-pandemic.

“It is a historical irony that the British government opted for a more continental economic policy after leaving the EU,” he said.

Barclays’ Cau said a U.S. 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 percent 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 percent, while energy and industry are among the highest. Because of this, tax hikes can encourage the prevailing rotation of stock investing from growth to depleting stocks of the “real economy” as the recovery matures.

With stock markets back to record highs overall, investors don’t seem to be concerned about the upcoming taxes. Massive government support and capital expenditures as well as historically still super cheap loan rates contribute to this.

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.

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