US Corporations Wallow In Tax Windfall; Profits And Taxes Diverge, Possibly Unsustainably -

US Corporations Wallow In Tax Windfall; Profits And Taxes Diverge, Possibly Unsustainably

Nov 07, 2018Jeremy ParkinsonFinance0

Thanks to last year’s tax cuts, corporate taxes have seen a big drop, with a wide gap between what corporations make and what they pay in taxes. While this gives them more money to spend on dividends and buybacks, this also raises the risk the divergence in due course will reverberate through the economy.

The Tax Cuts and Jobs Act of 2017 was signed into law on December 22 last year. Among other things, the US corporate tax rate was lowered from 35 percent to 21 percent. One-time repatriation of profits socked away overseas is taxed at eight percent, 15.5 percent for cash.

We are beginning to see the new law’s impact on corporate income statement. S&P Dow Jones Indices points out that the tax rates for S&P 500 companies in 1Q and 2Q this year are the lowest since at least 1993 (Chart 1), and that the average quarterly tax rate in 1993-2017 is 32.4 percent.

In the first half this year, the difference between what corporations earn and what they pay in taxes got much wider (Chart 2).

In 2Q, non-financial corporate profits before tax ex-IVA (inventory valuation adjustment) and CCadj (capital consumption adjustment) came in at a seasonally adjusted annual rate of $1.26 trillion. This measure of profits peaked at $1.44 trillion in 3Q14, but have been in the $1.2- to 1.3-trillion range for six years now. Corporate taxes on income, too, have been dropping since reaching a cycle high three years ago, but came under genuine pressure in 1Q and 2Q this year. The two have diverged – profits up, taxes down.

At the risk of stating the obvious, this should help drive up margins.

Chart 3 calculates the share of non-financial corporate profits adjusted for inventory valuation and capital consumption in national income. On an absolute basis, in 2Q18, they were respectively $2.24 trillion and $17.46 trillion – both new highs. In 2Q18, the margin proxy rose to 12.8 percent. This has risen since bottoming at 12.2 percent in 4Q15, with the all-time high of 14.5 percent in 1Q12. Conceivably, given the new tax regime, the red line in the chart can push higher.