Who will pay a corporate tax increase in the United States?

Joe Biden intends to raise taxes on corporate profits and is likely to do so. It may not fully achieve the expected 21 percent to 28 percent rate, but some increase is likely.

Who will bear the heaviest tax burden: companies, employees or shareholders?

Higher corporate taxes mean lower earnings per share. Naively, and all other things being equal, this would suggest that the shares should be worth less. The value of a stock is the present value of its future cash flows. If the discount rate applied to future income stays the same and income goes down because of taxes, the price should go down. The shareholders therefore pay.

Still, the U.S. stock market has only risen since Biden became the frontrunner, won the election, and finalized his tax plan (which was broadly clear).

However, not everything else is created equal. Perhaps the exuberance at the end of the pandemic overcame the tax news brake. But the point can be generalized. The corporate tax rate fluctuated wildly, from almost zero before 1917 in adolescents until WWII, to almost 50% in the middle of the century, and then to between 30 and 40% from the 1980s until Trump cut him off. at 21% in 2017. But long-term data on earnings, earnings growth and valuations show no gradual changes accompanying changes in the rate. The market doesn’t care.

Economist Paul Krugman used to think that the tax came from corporate investment. This point of view makes sense. The market sets the overall rate of return expected by investors. This is the limit rate that business investment must exceed. Higher taxes reduce the return on investment for businesses, so less potential investment crosses the hurdle. So there is less investment and less economic growth.

That’s why, as Krugman recently wrote, cutting corporate rates was the part of Trump’s 2017 tax cut he didn’t like the least. Now he thinks he was wrong because business investment has not budged from gross domestic product.

Why not? First, he says, most business investments are funded by debt, which is tax deductible anyway. Second, most business investments in software and equipment last only a few years, so the cost of capital is less (in the same way that a mortgage rate is more important to an individual than what is required. ‘he pays on a car loan). Finally, companies like Apple, Amazon and Google are virtual monopolies with enormous market power. Monopoly profits are free money, not return on investment, so they ignore taxes.

Andrew Smithers – venerable City economist and sometimes a contributor to the Financial Times – disagrees. On issues of debt and the lifespan of investments, he cites data from the Bureau of Economic Analysis and the Fed, which shows that the average lifespan of corporate fixed assets is 16 years and that net debt represents only 30% of the capital of companies. employee. With regard to monopolies, the share of profits in production has not increased in recent years and is close to historical averages, which is incompatible with claims of growing monopoly power.

But Smithers’ rebuttal is as logical as it is factual. Corporate tax should be excluded from the capacity of the private sector to consume or invest. If it leaves consumption, it could affect three groups: shareholders of companies, creditors or employees. We know that stock returns to shareholders have been constant over time regardless of the corporate tax rate, so shareholders don’t pay. We know lenders don’t charge less interest when taxes go up, so creditors don’t pay. And Smithers argues that firms’ wages relative to output have been stable over time, reversing the average regardless of the corporate tax rate. So the employees don’t pay. Private investment is the only thing left for taxes.

Smithers believes the reason investment did not increase further after the tax cut is due to distorted executive incentives. In a “bonus culture”, executives prefer to buy back stocks to increase earnings per share and their share price rather than investing for long-term growth.

I’ll let better economists than I call the winner here. But my experience working for an investment fund makes me lean heavily on Smithers. What we were looking for were companies that increased free cash flow, that is, profit after investment and taxes, which could be returned to shareholders. Companies know this is what investors want and promise to do it. If taxes go up, something has to be cut to keep giving investors what they want. Long term investing is a natural place to look.

robert.armstrong@ft.com

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