The 2017 tax law cut taxes a lot for corporations, with only minor cosmetic changes for most individuals. Where did the stimulus go? The top 100 giant multinationals may not have benefited from the new law as they lost their ability to have tax-free offshore transactions and must now pay a minimum of 12.5% tax if the move the new income to the U.S. or 14.5% if they insist on keeping income offshore. Income earned before the new tax law was enacted must be repatriated and a smaller tax rate is used. Thus the tax break went to medium and small companies. The tax law restricts the benefit for self-employed professionals in personal service companies, so the law is intended to help domestic sited US companies who produce non-professional goods and services such as a manufacturer or a construction company.
Since this is the era of outperformance for elite service industry firms like software consultants, CPAs, attorneys, etc. then the industries growing the most are restricted from using the tax break. (The tax benefit qualification cap is $160,000 income from all sources for a single person who is running a personal service business).
About 30% of the Small Cap index stocks currently are losing money and thus don’t need tax relief. The new law restricts corporate loss carrybacks and carry forwards, thus diminishing benefits to companies that lose money. So who is getting the benefit? Domestically based small and medium firms that are successful are benefiting. But why didn’t they take their stimulus and get excited and expand their plant, equipment, and employees?
Because the all-in cost of capital is still too high even with a tax cut from 35% to 21%. This is because manufacturing is hurt by competition from low wage EM countries. This force is stronger than the force of a tax cut. The cost of capital is a hypothetical cost that includes a risk premium as well as the cost of financing, including a hypothetical charge for use of equity capital instead of debt.
A potential reason for a shortfall of corporate interest in using the tax break is that foreign based companies, in theory, should want to relocate to the U.S. to take advantage of the new law. They didn’t partly because the law used the Byrd amendment provision requiring sunsetting in 9 years and thus if it takes several years to develop a business then by the time it became successful the law would have sunsetted, and there is risk the Democrats could return to power next year and simply repeal the law. The risk of that is too great for a foreign company to justify moving a giant factory from high tax Europe or Japan to the U.S. Also U.S. tax law tends to be very sticky and tries to control foreigners by claiming a foreigner (or a US émigré seeking to renounce citizenship) can’t simply resign his Green Card or citizenship and go to a foreign country and stop paying US tax until a long wait of many years. Many foreign countries allow more freedom for their citizens who manage an offshore business; it may be wiser for a foreigner or a foreign company to avoid locating a company in the U.S. in terms of avoiding long term tax entanglements.
The big picture is that global macroeconomic factors such as low wage EM countries are creating a disinflationary environment that is stronger than benefits from typical tax cuts (especially when discounting the risk of a sudden repeal by a newly elected Congress) and very much stronger than the ridiculous placebo of central bank’s Quantitative Easing.
The tax cuts should have been done with a bipartisan non-Byrd amendment law with a specific goal to encourage Developed country foreigners to move their businesses into the U.S. permanently by offering some guarantee of decades long tax stability and no tax penalty for withdrawing from the U.S. We have the best blue collar workers and they are the least expensive of a Developed country when counting fringe benefits and payroll taxes, assuming the company is in the rural south or many non-urban Rust belt areas.
Investors need independent financial advice about the risk of misunderstanding how tax changes can stimulate the economy. The tax cut did delay the recession by a year but didn’t structurally change anything that would result in more employment. The cuts may have made some tax matters offshore slightly more efficient such as the BASE section of the law that stops giant U.S. companies from getting away Scot free, as they now must pay at least 12.5% to the U.S.
The big global problem is that EM oligarchs, using cheap EM labor, hoard global wealth and create a global low yield “Savings Glut”. This force is more powerful than sunsetting restricted tax cuts, especially since EM oligarchs don’t want to commingle their economic activities with the U.S. economy and get their data entered into the U.S. economic databases, etc. So now we get stuck with more debt from the larger deficit and an even bigger non-productive, non-stimulative Savings Glut.
As investors wake up to the placebo nature of the tax cut they will become bearish and reprice stocks lower.