Certain politicians are decrying a tax move known as an “inversions,” which allow a U.S. company to merge with a foreign one with a more favorable tax rate.
Yet, it’s the politicians who created the necessity for such moves by maintaining a U.S. corporate rate that is the highest in the developed world at 35%.
But if corporate tax rates were reduced so as to be in line with the rest of the world, several major companies would see huge benefits.
Corporate Taxes and Inversions
While U.S. corporations pay 35% federal tax (39% when state taxes are added), Ireland is at 12.5%, the UK is at 20% and Canada is at 26.5%.
Further hurting U.S. companies is the practice of “double taxation.” When a U.S. corporation earns income in another country, it must pay taxes to that country. Then, the U.S. requires companies to pay our 35% rate on the profits that were already taxed in that other country. This is punitive and a disincentive to keeping businesses in the U.S. Most other countries only tax domestic income.
Maybe that’s why 20 U.S. companies have run screaming to relocate.
And that’s why companies are keeping their foreign profits overseas. There’s about $2 trillion invested abroad. A fifth of that is held by Microsoft (MSFT), Apple (AAPL), Google (GOOGL, GOOG) and five other technology firms.
Imagine what could be done if that was here. How many jobs would that create? How many shareholders would be rewarded with dividend increases that they, in turn, would spend or invest in our economy?
Tax Rates Lead to Foreign Buyouts
Also, wonder why so many U.S. companies are being bought out by foreign corporations? Because once a U.S. company becomes a subsidiary of a foreign company, that country’s tax rate is used. So a foreign operation can gobble up the income from a U.S. company, yet only pay taxes on that revenue at its home country’s rate.
Even worse, it increases the chances that jobs and R&D operations get moved abroad.
Other countries have realized the advantages of lower corporate tax rates. That’s explains The Tax Foundation’s report that, from 2004 to 2014, the average marginal tax rate in Europe fell from 27.2% to 18.6%, and the average marginal tax rate in Asia fell from 31.2% to 20.8%.
Following the UK’s lowering of its corporate tax rates from 28% to 20%, it has seen a 50% rise in the number of corporations seeking to domicile there. By 2017, the UK is on track to have more corporations than the U.S.
What has the reaction been here in the U.S.? At the federal level and on the campaign trail, certain politicians are criticizing corporations for leaving. The Treasury Department has released rules to try and stop them. At the state level, it is arguably worse.
In New Jersey, the Assembly passed legislation that would prohibit companies that utilize corporate inversions from receiving or maintaining state contracts or economic development grants. Common sense dictates the outcome of this legislation — companies will just take their investment dollars and their jobs and go somewhere else. Other states would be foolish to follow New Jersey’s lead.
The solution to all this is for Congress to lower the U.S. corporate tax rate and get rid of the “double tax.” This would level the playing field for U.S. companies and significantly benefit U.S. economic growth — at both the federal and state levels, at a time when we badly need it.
So Who Benefits?
Investors see huge benefits from inversions, but even greater ones from a lower tax rate.
For inversions, it means more money is available for growth and investment in the economy. I haven’t been high on Pfizer stock for years, but an inversion is going to free up billions of dollars. Combined with Allergan (AGN), it should give Pfizer a huge cash bundle to be competitive again.
We’ve got a slew of other potential inversion deals. Aggressive investors may want to consider buying calls or going long if these inversions occur, although remember to assess the underlying fundamentals of each. The companies include:
- Pfizer (PFE)
- Medtronic (MDT)
- Walgreens (WBA)
- C&J Energy Services (CJES)
- Mallinckrodt (MNK)
- Mondelez (MDLZ)
- Applied Materials (AMAT)
- Horizon Pharmaceuticals (HZNP)
On a macro level, if the federal government gets its head on straight, perhaps we will see corporate taxes get cut. If that happens, it will be bullish for the entire market and the entire economy.
It could plow trillions of dollars back into the coffers of corporations. They will use those funds to invest in themselves, invest in jobs, invest in the economy and very likely boost dividends. Given how popular dividends are with a wide swath of investors, it should cause a stampede into those stocks, especially.
If this ever happened, even if we were in a bear market, I would consider it a huge bullish sign. I would buy Apple, Google and Microsoft, as well as market exchange-traded funds like the SPDR S&P 500 ETF (SPY), PowerShares QQQ ETF (QQQ) and any of the Russell 1000 and 2000 growth and value ETFs.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.