President Donald Trump’s recently proposed tax cut plan cuts corporate taxes from 35 percent to 15 percent, and also calls for a one-time tax break for corporations repatriating overseas from abroad. The latter measure is meant to incentivize U.S. companies to bring cash they’re holding overseas back to the U.S.
The idea is that the influx of capital should spur major economic growth and job creation as American companies put that money to work by expanding their businesses. Building new factories, buying new equipment, spending more on R&D — that sort of thing.
Trump has promised to spark 4 percent GDP growth through his policies, and encouraging companies to repatriate the estimated $2.6 trillion stuffed in overseas coffers is a central part of that plan.
[See: 5 Reasons Donald Trump’s Presidency Will Include a Recession.]
And it’s a prime example of why economics still isn’t a science. Much of that repatriated cash will go to stock buybacks, dividends, and acquisitions — investments that would enrich shareholders, not strengthen America’s job market.
Here’s why Trump’s proposed repatriation tax holiday isn’t quite the stimulus package it’s trumped up to be.
The hard truth. Many large corporations will suddenly see huge cash windfalls from the combination of lower tax rates and an influx of overseas capital.
And Fran Reed, Regulatory Strategist at FactSet, notes that corporations have quite a few options for how to use that windfall.
“They can either create new jobs and capex for expansion or they can create greater shareholder wealth through dividends and stock buybacks. There are some other issues to consider, but that’s the main line of reasoning why corporate tax cuts incentivize buybacks and dividends,” Reed says.
So the idea that American companies will immediately go on a hiring spree is not at all a necessary consequence of the cuts.
Those who don’t learn from history… Perhaps the clearest evidence that a tax holiday will finance stock buybacks, not new jobs, is history: This has been done before.
In 2004, one-time tax holiday for the repatriation of foreign earnings trimmed tax rates from 35 percent to just 5.25 percent.
“The reason that some experts are projecting that another tax holiday could result in a significant increase in stock buybacks and dividends is that research surrounding the first tax holiday documents this effect,” says Stephen J. Lusch, assistant professor of accounting at the University of Kansas.
“The primary use of the repatriated funds was to increase shareholder payouts, particularly stock buybacks, rather than increase firm investments such as capital expenditures, research and development spending,” or other such productive, non-financial initiatives, Lusch says, referencing the 2004 tax holiday.
A 2011 report by the Permanent Subcommittee on Investigations in the Senate studied that 2004 tax break and found that just 15 companies accounted for nearly half ($155 billion) of the total money repatriated ($312 billion).
Stock buybacks at those 15 companies then grew by 38 percent between 2005 and 2006, while executive compensation grew by 27 percent in 2005 and 30 percent in 2006, according to the report.
As for job creation? Those same 15 companies cut more than 20,000 net jobs between 2004 and 2007, the report found.
The market is telegraphing how Apple will use its savings. The company with the most to gain from the repatriation tax holiday is Apple ( AAPL), which has about $240 billion in cash sitting overseas. The stock market is quite aware of that, which is why, since Trump’s election, AAPL stock has been soaring.
Shares are up 33 percent since Nov. 8, outperforming the Standard & Poor’s 500 index by 21 percentage points.
While some of that increase can be chalked up to a good holiday quarter, much of the rally was simply due to the anticipated tax windfall coming Apple’s way, which analysts openly expect AAPL to spend on boosting its capital return program (i.e. buybacks and dividends) and perhaps making a big acquisition.
Analysts have suggested companies like Netflix ( NFLX), Tesla ( TSLA), Walt Disney Co. ( DIS) and Twitter ( TWTR) as potential takeout targets. But like buybacks and dividends, acquisitions only enrich shareholders. In and of themselves they do nothing for jobs or the economy — in fact, they often result in layoffs.
[Read: The Top M&A Targets in 2017.]
In short, the one thing analysts don’t expect Apple to invest in with its payday is new American jobs.
Why Uncle Sam shouldn’t finance stock buybacks. The biggest reason these inevitable buybacks and dividends are “bad” is because they will do nothing to create American jobs — the sole reason politicians argue the tax holiday is necessary.
Even under normal situations stock buybacks can be a bad idea. It’s not uncommon for management buy back stock when it’s overvalued, or use repurchases as a tool to reach earnings per share goals that earn them fat bonuses. In both cases, buybacks aren’t even in the best interest of the shareholder, much less the taxpayer.
And even when buybacks are executed perfectly, they simply don’t develop or improve the company, fund innovations and discoveries, or directly create a single job.
They enrich shareholders, who are already well off. That, in turn, contributes to more income inequality, which is itself bad for the economy.
A better solution. The concept of slashing the cost of repatriating money sounds nice in theory. But in practice, companies care far more about artificially increasing their share prices than hiring American workers. Essentially the largest corporations in America will be given billions of dollars in free cash by the U.S. government (i.e., the U.S. taxpayer) to spend as they please.
As long as there are no strings attached on how or where companies spend these savings, taxpayers get a raw deal.
If instead there were a requirement to spend a big chunk of tax savings on hiring, capital expenditures, research and development, or other U.S. expansion efforts — that would make much more sense.
The net effect. For investors and large corporations, these tax cuts will be a godsend. How dramatic the tax break on repatriation will be is up in the air, but it figures to be significant.
Some analysts are even beginning to model “what-if” scenarios in which large-cap technology growth stocks like Amazon.com ( AMZN), Alphabet ( GOOG, GOOGL) and Facebook ( FB), which don’t currently pay dividends, begin paying them under the new plan.
[See: 7 of the Best Cheap Stocks to Buy Under $10.]
The outlook is less sanguine for unemployed or underemployed Americans seeking quality, long-term jobs.
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Why Trump’s Tax Cut Plan Will Fuel Stock Buybacks, Not Jobs originally appeared on usnews.com
