US Corporate Governance/The New Tax Law Comes with Complications

posted by Marsha Vande Berg on January 23, 2018 - 11:06am

While an optimistic consensus in corporate America is growing around last year’s passage of a sweeping US tax bill, corporate boards would be wise to pivot their spending deliberations to how companies can catalyze new technologies on behalf of improvements in real wages, growing jobs and educating the workforce. This should be the preference over stock buybacks and shareholder dividends if the US economy is to realize more than a one-time, feel-good growth spurt.

A cornerstone of the 2017 Tax Cuts and Jobs Act is an expectation that corporate America will do just that: redirect their collective windfall to re-building their work force capacity and increasing real wages. Mixing metaphors, the dramatic reduction in corporate tax rates is seen as the “crown jewel” and productivity the “holy grail.” 

Corporate America’s tax playing field is being leveled. It’s now time for corporations and their governing bodies to ensure the playing field gets leveled for workers.

From the get-go, the gap between corporate profits and wages as a share of GDP is wide – 51% to 43%.  Corporate profits are just off their highest level since 1950 while labor is stuck at an all-time low, according to Goldman Sachs US productivity report.

Narrowing that gap will be critical to the tax law’s ultimate success. And that can happen only if the cuts are a genuine boon to the US economy and work to offset the trillion-dollar deficit hit that’s forecast.  Likewise, figuring out how to increase capacity at a time of a virtually full employment market will also be critical to the success of the remaining three years of Trump’s very volatile presidency.

Some parts of corporate America are stepping up. In the retail sector, giant Wal-Mart announced early on in response to the new law’s dramatic reduction in the statutory corporate tax rate from 39 to 21% that the world’s largest retailer intends to increase its starting wage to $11/hour and hand out employee bonuses.  In technology, the giant Apple went one better, responding to the rate cut, eased restrictions on repatriation of overseas profits and the new 100-percent capital expense deduction in the year the capital expenditure is posted.  The world’s most valuable company said it will repatriate the more than $200 billion it has stashed abroad in overseas-earned profits, paying a one-time penalty of $38 billion; hire 20,000 additional US workers; and invest $30 billion on US facilities, including a new campus, $10 billion toward data centers and an increase in its Advanced Manufacturing Fund.

Meanwhile, fourth quarter accounting adjustments necessitated by the tax law have obscured at least temporarily the all-out impact on another key sector, financials and banks in particular.  Such issues also underscore just how complex implementation of the new law will prove to be given the extent of questions that still resolving before full implementation can be underway.  Adopted in record time and without the requisite vetting via bipartisan committee debate, the new tax law passed Congress without a single Democratic vote and with yes votes only from congressional Republicans. It was signed into law two days later by President Trump.

When it came to guidance from the administration, lawmakers only received paltry one-page analysis from US Treasury Secretary Steve Mnuchin, sizing up the impact of the trillion-dollar-plus hit to the federal deficit, half of which the secretary said has to come from new corporate tax revenues. The remainder should come from albeit temporary individual tax-bracket changes now in place for some, not all Americans, deregulation, infrastructure development and reductions in entitlements, affecting possibly Social Security, Medicare and low-income benefits, almost all of which will require bipartisan backing.

JP Morgan CEO Jamie Dimon struck a positive note for the banking sector, seemingly relegating to history the once brittle cries of Occupy Wall Street a decade ago.  The law was a “big, significant positive, and much of it will fall to our bottom line in 2018 and beyond,” he said. Citigroup and Goldman Sachs executives agreed that substantial hits to their respective balance sheets in the fourth quarter of last year would give way to substantial long-term gains.

Practically speaking, corporate American has long since positioned itself to be in the 22-25% income tax bracket, taking advantage of various loopholes. Now they have the benefit of a statutory rate decrease against a favorable backdrop of a strengthening global economy.  For commercial banks, there is also the probability of higher interest rates in 2018 boosting loan growth. Investment banks meanwhile can count on the tax and deregulation headwinds to boost bottom lines as optimism spreads to merger and acquisition targets.  

The optimism amid corporate America is palpable as President Trump heads into his second year in office. He effusively claims credit for unleashing the animal spirits that can drive tailwinds. But as anyone knows who watches markets, tailwinds blow over and guaranteed promises of success are meaningless.

Retiring New York Fed President Bill Dudley painted a far-different scenario about longer-term implications of the tax cuts.  Speaking to the Financial Times, Dudley warned that while a short term lift is likely, the increase in government borrowing as a result of business’ one-time ebullience can boomerang, driving a faster pace of interest rate hikes than normalization is anticipating in 2018. If that’s the case, a Federal Reserve dominated by Trump appointees will also be in the prickly position of deciding whether to increase rates at a faster pace in an election year.

For the tax cuts to work to the benefit of a truly stronger and inclusive economy, US policy and business alike have to begin to address the need for workforce restructuring in the face of technology advancement and the need for education and re-training, America’s dominant ageing demographic and Trump’s hardline immigration policies.

Neither corporate governing bodies or policymakers dare be sanguine about the outcomes these developments portend for 2018 and Trump’s second year in office.