Tech companies like Alphabet ( GOOGL ) and Apple ( AAPL ) and drugmakers like Pfizer ( PFE ) that have amassed piles of cash to avoid paying high domestic tax rates on profits earned overseas have been singled out as big potential winners under Trump's tax reform, but don't count on it. When push comes to shove in getting the U.S. corporate rate down to 20%, or close to it, to "make America great again," the revenue lost to international tax havens may be needed to make the numbers work.
The GOP tax framework released late last month reiterates President Trump's long-held goal to "bring back trillions of dollars that are currently kept offshore to reinvest in the American economy." To that end, the plan would require that accumulated profits held offshore be repatriated, but at a much lower tax rate than they would have faced under existing law if they voluntarily brought the cash back home.
The idea excites investors, who anticipate that the freed-up cash will translate into bigger stock buybacks, dividends and cash-funded acquisitions. Meanwhile, U.S. multinationals are so far on board with what would essentially be a retroactive tax hike because the GOP plan also would give them permanent relief on profits earned both at home and abroad.
Apple could hit a $1 trillion market cap under tax reform, RBC Capital Markets speculated Tuesday.
But there are some pretty big risks to this story. The first potential trouble spot arises straight from the tax reform framework.
International Minimum Tax
The GOP has long wanted to shift the U.S. to a territorial tax system that taxes corporate profits in the country where they are earned, as most other nations do, instead of taxing international profits only when (and if) they are repatriated, with a credit for foreign taxes paid. But the new Republican tax plan doesn't quite go that far. Instead, it endorses a minimum tax on international profits, though at a "reduced rate" relative to the proposed 20% rate paid on corporate income earned in the U.S. The first risk is that this unspecified reduced tax rate could end up being higher than some companies now pay on overseas earnings.
Take Pfizer, which had an international tax rate of 9% in 2016 ($1.5 billion in current taxes on $16.9 billion in profits), even before deferred income-tax credits that further shrunk the bill. Alphabet had an even lower current international tax rate of 7.9% ($966 million on profit of $12.1 billion). Apple's international tax rate in fiscal 2016 was just 5.1% ($2.1 billion in current taxes on $41.1 billion in income).
Now suppose that the minimum tax rate on foreign profits is set as high as 15%, or three-fourths of the proposed 20% U.S. corporate tax rate. Under such circumstances, the rewards of tax reform might look a whole lot leaner for Google's parent and turn into a downer for the maker of Viagra.
While there's no indication that the international minimum tax rate will get as high as 15%, political aesthetics and budgetary math both raise the risk that some companies could face significantly higher international tax rates than they do now. Alphabet, which owed $3.5 billion in current federal taxes on U.S. revenue of $12 billion, would still see a lower overall tax bill if the U.S. rate gets knocked down close to 20%. But a high minimum rate would surely lower the appeal of tax reform to a company like Pfizer, which has regularly reported losses from U.S. operations and doesn't stand to gain much from a lower U.S. corporate rate. Although Pfizer got almost exactly half its $52.8 billion in revenue from the U.S., it pays relatively little federal tax ($342 million in 2016, before deferred tax credits worth $419 million).
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Testifying at a Senate Finance Committee hearing on international taxation last week, Reed College economist Kimberly Clausing estimated that "profit shifting to tax havens now costs the U.S.
government more than $100 billion each year."
At the hearing, both Clausing and Stephen Shay, who served in the Treasury Department under Presidents Obama and Reagan, noted problems with the Republican idea for a minimum tax that is applied to foreign earnings on a cumulative basis, rather than on a country-by-country basis. Clausing estimates that 98% of profit shifting relates to countries with a sub-15% tax rate. Under one global minimum rate, Shay said that companies could seek to preserve their tax savings from shifting income to low-rate countries by increasing investment in higher-rate countries.
It's worth noting that one of the "international" tax havens popular among pharmaceutical and biotech firms is Puerto Rico, which is a U.S. territory but is categorized as international in corporate filings. Puerto Rico's mounting troubles make it unlikely that tax policy will penalize companies with manufacturing facilities there.
The biggest hurdle to cutting the U.S. corporate tax rate is the budgetary math. Republicans are trying to squeeze about $2.6 trillion in business tax cuts into a $1.5 trillion hole, leaving little room for individual rate cuts. Beyond 10 years, the math gets a lot worse, casting doubt on whether permanent tax changes are doable.
To utilize the Senate's filibuster-proof reconciliation process, the GOP plan can't add to deficits beyond the first decade, yet cutting the corporate rate to 20% will alone cost $3 trillion in the second decade , according to an analysis by the Tax Policy Center. As of now, the GOP has only spelled out about $300 billion in savings from repealing business tax breaks.
If the 20% corporate rate starts moving higher, the risk is that the international minimum rate will move along with it.
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