Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Tom Walker, manager of the Martin Currie Global Portfolio Trust discusses how tax reforms could boost certain US stocks.
The political landscape in the US has changed once again following the recent midterm elections, but one big issue remains high up the agenda for both parties – tax.
An estimated $2 trillion is sitting in offshore cash piles and the politicians would like this to flow back to the US. If that happens, some companies could benefit disproportionately providing opportunities for stock pickers. One thing is certain: US tax reform is never simple.
Taxing Times
At 35%, the US has one of the highest top-line corporate tax rates in the developed world. That has led to a rash of US companies relocating overseas – so-called corporate ‘inversions’ – and taking the requisite jobs and investment with them.
Currently, on repatriation, US companies’ foreign earnings are taxed at the same rate as their domestic operations and this acts as a barrier to multinationals bringing their foreign profits back to the US.
Earlier this year, President Obama voiced alarm about the continuing flood of corporate relocations, and tax reform was pushed higher up the political agenda.
But even with a degree of common ground between political parties, stemming the pace of inversions and simplifying the tax system is easier said than done.
Tax Holiday: A New Stimulus?
One proposal calls for the re-introduction of a temporary ‘tax holiday’ that would enable multinational companies to repatriate foreign earnings at a hugely discounted rate.
Economists generally agree that tax repatriation would be positive for the US economy and its asset markets. Some speculate that it could even act as a de facto stimulus measure akin to the Federal Reserve’s bond-buying programmes.
But sceptics point to the indefinite effects of the last tax holiday (which took place between 2004 and 2005) when the effective rate of tax on foreign earnings was slashed to just 5.25%. They believe that the potential benefits of a new amnesty may be somewhat exaggerated by its proponents.
For a start, the impact of the tax reductions may be fairly negligible for many companies, especially those who already gain from the raft of loopholes and dispensations in the current system.
Secondly, many companies are risk averse at present, and are more likely to use cash to buy back shares than to begin capital expenditure programmes that might boost domestic economic growth.
Who Would Benefit From A Tax Holiday?
As a stock picker, I am acutely aware that the tax break could also favour different companies and sectors of the economy disproportionately.
In my view large companies, in particular technology and pharmaceutical multinationals are most likely to be the main beneficiaries as they could repatriate significant cash piles currently stranded offshore.
Many companies that raise domestic debt to pay for dividends and share buybacks would also directly benefit from using this newly available cash should interest rates rise.
The repatriation of such a large amount of cash may strengthen the US dollar further which could have a significant global macroeconomic impact. Any increase in dollar strength would likely undermine the growth in emerging economies – and the companies with large exposure to those markets.
In this scenario, US companies that are net exporters would suffer but those with more domestic-based earnings, or net importers, would experience a twofold benefit – profiting from the dollar rise while cashing in on any additional stimulus to the domestic economy.
Wide-Reaching Change
The potential impact of any such reforms will be closely scrutinised, not least by global investors. If initiated, we would like to see tax changes that are wide reaching and encompass fundamental structural reform – removing the existing loopholes, inefficiencies and disparities – not just addressing the headlines of tax reduction and repatriation.
Lessons Learnt?
For US politicians, no doubt the principal aim of corporate tax reform will be to stop the flight of US companies to foreign shores.
However, if lessons have been learnt from previous tax reforms, the focus will be on delivering a simpler and more efficient system for US companies – an outcome that would benefit the US economy as a whole.
If progress is made, the impact on different companies and sectors is bound to throw up interesting opportunities for stock pickers.
Disclaimer
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