The prospect of a corporate tax holiday for repatriated foreign earnings is unlikely, and even if it were to become law, it would have minimal impact on the economic outlook, notes JPMorgan.
Dubravko Lakos-Bujas and team at JPMorgan in their March 4, 2015 research report titled: “The Prospect for Repatriation of Foreign Earnings. 25 US Multinationals with Highest Cash Balance Abroad” believe multinationals have left substantial earnings in controlled foreign subsidiaries, over $2 trillion.
Equity market implications under three scenarios
The JPMorgan analysts note the corporate tax rate in the U.S. is among the highest in the developed world, with U.S. multinationals paying well below this rate, while domestic companies pay closer to statutory tax rate.
The analysts point out that in order to avoid, or at least defer, the tax liability, corporations have left substantial earnings in their foreign affiliates, by some reckoning around $2 trillion.
They note the president recently proposed a one-time tax on all current un-repatriated earnings coupled with a lower statutory, but higher effective rate on future foreign earnings.
Lakos-Bujas et al. note that despite the fact the prospect of a corporate tax holiday for repatriated foreign earnings is generating renewed interest, they believe the odds of a repatriation holiday being enacted are quite low. Moreover, they believe even if it were to become law, theory and recent empirical evidence indicate it would have a minimal effect on the economic outlook.
As can be seen from the following graph, there was no visible effect on capital spending after Congress instituted a one-time tax holiday in 2004:
The analysts also point out that recent research found repatriation had little impact on capital spending, employment or R&D outlays. On the contrary, they note repatriation was associated with an increase in shareholder payouts.
Sharing their views on how a potential repatriation holiday would affect U.S. equities, the analysts considered three scenarios. Under the first scenario, the analysts have taken a scenario where the proposal is approved without amendment.
In the remote event of this becomes law, the JPMorgan analysts anticipate that the new tax proposal for S&P 500 companies to be neutral to slightly positive in aggregate with the effective tax rate for the index dropping by roughly 50 bps to 28.0%. However, the analysts anticipate that $35 billion of the S&P 500’s total tax burden would shift from U.S. domestic companies to multinationals.
Status Quo most likely scenario
As a second scenario, the JPMorgan analysts consider the situation where under pressure from multinationals, the corporate reform morphs into a voluntary repatriation holiday.
The analysts point out that various pieces of legislation have been proposed over the past few years calling for a repatriation tax holiday allowing firms to voluntarily pay tax on previously untaxed accumulated foreign earnings. However, the analysts note considering the president’s stated opposition to one-time holidays without a broader corporate tax reform, this proposal also appears unlikely to move forward anytime soon.
They also consider a third scenario where the status quo hholds They note the status quo with little corporate tax reform and no cash repatriation is most likely to prevail with Congress and the president finding little common ground over the issues.
Dubravko Lakos-Bujas and team believe with the status quo maintained, U.S. corporates would continue to grow earnings at a high-single-digit rate with enhanced corporate actions including higher buyback and M&A activity with or without repatriated cash.
