The Trump Tax Plan - Who is Really Benefitting From the Corporate Tax Cut

Thanks to the Trump Administration's tax reengineering and research done by the Institute on Taxation and Economic Policy, we now know how the changes to America's corporate tax regime benefitted Corporate America.

While Main Street America pays the lion's share of Washington's tax revenue as shown on this graphic:

...the situation has worsened since the introduction of Donald Trump's 2017 Tax Cuts and Jobs Act with corporations now remitting only 8.1 percent of the federal government's total tax receipts, the lowest level since the Great Depression as shown here:

To compound the issue, research by the Institute on Taxation and Economic Policy (ITEP) found that 60 of America's largest publicly-held profitable corporations paid absolutely no corporate income tax in 2018, more than twice as many as the average in previous years.  These companies earned $79 billion in U.S. pre-tax income and, rather than paying $16.4 billion in corporate income tax at the new 21 percent statutory corporate tax rate, they benefitted from a net corporate tax rebate of $4.3 billion.

Here are the top five earning companies that paid no tax (or received tax rebates) in order of earnings, the top five companies that had negative tax rates and the top five companies that received federal tax rebates:

As you can see, some of these companies are highly profitable and are among America's largest corporations.  If you wish to see the entire list of 60 corporations, please click here.

Obviously, these companies are using a variety of legal tax breaks to write down their earnings to zero (or less).  Here are the most common:

1.) Accelerated Depreciation - allows companies to write off the cost of their capital investments (in equipment etcetera) at a much faster rate than these investments actually wear out.  For instance, Halliburton's use of depreciation-related tax breaks allow the company to reduce its taxes by $320 million.

2.) Stock Options - allows companies to write off stock-option related expenses in excess of the cost that they report to shareholders.  A 2016 study by Citizens for Tax Justice found that this legal tax break was used by 315 of the Fortune 500 companies and is one of the main reasons why stock options have become such an important part of executive compensation packages.  As one example, the highly profitable Amazon reduced its federal income taxes by over $1 billion in 2018 using this tax break.

3.) Fossil Fuel Tax Subsidies - allows companies to depreciate their oil and natural gas assets.  As one example, these tax breaks allowed Pioneer Natural Resources reduced its federal tax owing to $0 on $1.2 billion of its income in 2018.

4.) Tax Credits - allow companies to claim tax credits for research and development. As one example, thanks to $140 million in R&D tax credits (among others), Netflix ultimately received $22 million in federal tax credits on earnings of $856 million.

One would like to think that the corporate tax reductions introduced by the 2017 Tax Cuts and Jobs Act would have led to the creation of jobs or higher wages for workers but this is not clear.  What it has led to are two things:

1.) An increase in U.S. corporate stock buybacks which reached $1.1 trillion in 2018.  For the first three-quarters of 2018, buybacks were $583.4 billion, up 52.6 percent from 2017 while aggregate capital investment increased by only 8.8 percent and R&D investment grew by only 12.5 percent on a year-over-year basis.

2.) An increase in dividends paid to shareholders.  Based on the first eleven months of 2019, dividends paid hit a new record of $420 billion, up from $419.7 billion the in the prior year, another record year.  The beneficiaries of increased dividends flow mostly to large shareholders (i.e. Named Executive Officers and holders of large numbers of shares) while little of the benefit of dividends flows to Main Street America and their small shareholdings.

As we can see, the corporate tax cut of 2017 has proven to be very beneficial to a select number of Americans and their corporate employers, however, the benefits of the tax reduction have not flowed down to "Mom and Pop" who are playing a larger and larger share of Washington's tax revenue.  Since Washington's lawmakers are largely bought by Corporate America and its political donations, this should be of no surprise to anyone.  At least America's legislators know how to look after their corporate overlords.

Taxation in America - Who is Paying Their Fair Share?

As most Americans are aware, the Trump Administration has significantly cut taxes for Corporate America, touting the advantages that this will bring to the U.S. economy.  While I don't wish to get into discussing the advantages/disadvantages of the reduction of the headline federal corporate tax rate from 35 percent to 21 percent, there is an interesting aspect to both personal and corporate taxes that is rarely discussed, that is, the relationship between tax receipts and the size of the overall economy.

Let's start by looking at this graphic which is sourced from FRED showing how total federal tax revenues measure up against total gross domestic product going all the way back to 1929, just prior to the beginning of the Great Depression:

It is important to keep in mind that total federal tax revenues include personal income taxes, corporate taxes, other payroll taxes (Social Security, Medicare and unemployment insurance), customs and excise taxes and tariffs among others.  As you can see, total federal tax revenues have ranged from between 15 and 20 percent of GDP going all the way back to 1943 with some exceptions including the period between the Great Depression and the beginning of World War II when tax levels were far lower than they are today and for a brief period during the dying days of the Great Recession and the two years that followed.

Now, let's look at total federal corporate tax receipts as a percentage of GDP:

This graph is quite different from the previous graph and shows us that corporate tax revenue as a percentage of the entire U.S. economy has gradually fallen from a high of 7.44 percent in 1951 to its current level of 0.74 percent (Q1 2018), the lowest level on record.

Here is a graph showing federal personal tax receipts as a percentage of GDP:

Again, you can see that this graph more closely resembles the graph showing total federal tax revenues as a percentage of GDP.  In fact, at the current level of 7.9 percent, personal tax revenues are slightly above the 71 year average of 7.73 percent and are close to the highest levels seen since 2002.

Just in case you were curious, here is a graphic showing how federal corporate tax rates have varied over the past 100 years:

At its current level of 21 percent, Corporate America is paying taxes at the lowest rate that it has experienced since 1940.  While Washington is touting the job creation and enhanced employee benefits aspects of the new ultra-low headline corporate tax rate, evidence shows that a significant portion of the tax savings are being spent on stock buybacks.  As well, as you can see from this posting, Corporate America is paying less and less than its share of tax revenue when measured in terms of the overall economy while Main Street America bears the lion's share of the nation's overall tax burden.  This situation is only going to worsen under the new 21 percent headline federal corporate tax rate.

The Real Benefit of the Tax Cuts and Jobs Act to Corporate America

A recent study by Penn Wharton looks at the impact of the Tax Cuts and Jobs Act (TCJA) on federal corporate tax rates across 19 main industrial sectors over the next decade and compares them to current tax rates.  While the current administration in Washington is touting TCJA as the panacea to America's economic woes, the Penn Wharton study suggests otherwise.

I want to start this section with a definition that is used in the Penn Wharton study.  The effective tax rate is known as the effective tax rate (or ETR) which is calculated by dividing taxes paid by book income (i.e. pre-tax financial income as reported on company's income statements).   As you know, the current corporate statutory tax rate in the United States is 35 percent which will be reduced to 21 percent under the TCJA.  As you also know, most corporations pay taxes at a rate that is far lower than the headline tax rate thanks to various deductions, tax credits and tax deferral strategies; currently, the effective tax rate ranges from 18 percent (mining) to 33 percent (agriculture) and averages about 23 percent.  Under the TCJA, the effective tax rate average is projected to fall to 9 percent in 2018, however, it will double to 18 percent over the next decade as various tax provisions change. 

The authors of the Penn Wharton study calculated the effective federal corporate tax rate for various industries under both current law as well as under the TCJA's proposed amendments.  They note that there are several major provisions and phasing-out of provisions in the TCJA that will impact the calculation of ETR for each industry as follows:

1.) 2018 - corporate headline tax rate drops to 21 percent, increased equipment and software expensing, bonus depreciation is extended and expanded, net interest deceptions are limited, net operating loss deceptions are limited

2.) 2022 - Amortization of research and experimental expenditures, change in rules for the limitation of net interest deduction.

3.) 2023 - phasing out of extended and expanded bonus depreciation begins.

4.) 2026 - complete phasing out of extend and expanded bonus depreciation.

The Penn Wharton model shows that the effective tax rate average across all industries declines from 21.2 percent in 2017 to 9.2 percent in 2018.  Once the changes to various deductions begins in 2023, the decline in the effective tax rate is even smaller and is calculated at 17.33 percent.  By 2027, the decline in the average corporate effective tax is smaller yet again and is calculated at 18.27 percent, barely 3 percentage points better than it is currently and only 4.7 percentage points better than it would be under current tax law.  

Here is a table showing how widely variable the effective tax rates are for each of the 19 industries and how these tax rates will vary over time under the current law and under the Tax Cuts and Jobs Act:

As you can see, in a significant number of industries, a great deal of the tax savings under the TCJA evaporate over time.

Now, let's look at the details of the change in the dollar amounts of taxes (i.e. tax savings) each of the 19 industries will pay over the ten-year budget timeframe:

1.) Agriculture, forestry, fishing and hunting - $7.8 billion

2.) Mining - $38 billion

3.) Utilities - negative $15.6 billion

4.) Construction - $12.9 billion

5.) Manufacturing - $261.5 billion

6.) Wholesale trade - $146.5 billion

7.) Retail trade - $171.4 billion

8.) Transportation and warehousing - $62.7 billion

9.) Information - $99.2 billion

10.) Finance and Insurance - $249.4 billion

11.) Real estate, rental and leasing - $12.7 billion

12.) Professional, scientific and technical services - $22.7 billion

13.) Management of companies (holding companies) - $154.2 billion

14.) Administrative and support and waste management - $19.0 billion

15.) Educational services - $3.7 billion

16.) Health care and social assistance - $5.9 billion

17.) Arts, entertainment and recreation - negative $0.5 billion

18.) Accommodation and food services - $18.0 billion

19.) Other services - $4.6 billion

Notice that second biggest beneficiary of the proposed tax changes, thanks to the Tax Cuts and Jobs Act, is the finance and insurance sector which will benefit from about 19.5 percent of the total reduction in corporate taxes paid even though they pay only 17.8 percent of corporate taxes under current law.  No surprise there given this:

Despite Washington's touting of the Tax Cuts and Jobs Act as the ultimate answer to Making America Great Again, the Penn Wharton study shows that, while the TCJA reduces the effective corporate tax rate in 2018 to just 43 percent of its value under current tax laws, by 2027, most of that gain is lost as the effective tax rate rises to 80 percent of its value under current laws.  As well, with Corporate America's share of Washington's total revenue declining over the past decade as shown here:

...and with the mounting federal debt and rising interest rates, how long will it be before Washington is forced to raise personal taxes for those Americans who have no lobbying voice to speak on their behalf to Congress?

What Corporate America is Really Doing with their Tax Savings

Now that the Republican tax plan, flaws and all, has passed Congress, the repercussions of the changes, particularly to Corporate America, will continue to ripple through the markets.  While conventional wisdom would suggest that the reduction in the headline corporate tax rate in the United States would lead to increased employment and wages and greater investment in capital goods that will make American businesses more competitive on the world stage, such is not necessarily the case.

According to data published by the Democrats in the Senate, here's where Corporate America is likely going to spend even more of the tax breaks that they will be given under the Tax Cuts and Jobs Act:

In total, the companies that have announced that they will spend $100 million or more on stock buybacks has reached $70.2 billion in the slightly less than two week-long period between December 6th and December 15th.

Who does this benefit?  While the companies involved always use a boilerplate "It's to maximize shareholder value", such is not completely true.  Let's look at the stock holdings/stock awards/stock option awards of the Named Executive Officers (NEO) of the top four companies on this list as well as the Beneficial Ownership declaration which shows how much company stock is held by the company's NEOs and Directors:

1.) Home Depot:

Here is the insider ownership of stock by Home Depot executive officers and directors:

2.) Oracle:

Here is the insider ownership of stock by Oracle executive officers and directors:

3.) Honeywell:

Here is the insider ownership of stock by Honeywell executive officers and directors:

4.) Bank of America:

Here is the insider ownership of stock by Bank of America executive officers and directors:

With this data in mind, who do you really think that reducing the volume of outstanding shares for any of these five companies is really benefitting?  Obviously not the Mom and Pop investors who may own a few hundred shares at most nor is it benefitting employees.

Corporate America's insiders owe a great debt of gratitude to the Trump Administration for their munificent gesture.