Why have US tax cuts resulted in lay-offs and shareholder rewards?
Companies are adjusting their strategies to the Tax Cuts and Jobs Act (TCJA) that was passed in December 2017, but the effects haven’t all been positive.
With a tax rate that was lowered to 21% from 35%, companies have extra funds and a myriad of potential uses. Lower taxes are meant to encourage capital investments and increase wages that will ultimately bolster the economy, but sometimes, these funds are returned to investors and shareholders instead.
“The effective tax rate dropped substantially, and now, companies have more after-tax dollars to spend,” said Greg Wank CPA, Accounting and Advisory Partner at Anchin. “Will they give this back to stock-holders and invest? It’s a combination of both. They’re investing in their business so now they can take on less debt because they have more after-tax profits. They don’t have to borrow money. Are we also seeing that some is going back to the ownership? Yes.”
Public companies have been transparent about their strategy as these companies are beholden to their shareholders and tend to have more pressure to return income. Private companies, on the other hand, are not under the same pressure, as the owners are the decision-makers.
Indeed, many public companies have done what was expected and returned their tax savings to shareholders. During the April to May earnings season, companies announced $183.4bn in buybacks and $191.4bn during the January to February season, with more to come.
The many opinions on this strategy
Some argue that companies do stock buybacks as an attempt to increase share prices by lessening supply and also to meet earnings per share targets.
In March, Senator Tammy Baldwin of Wisconsin introduced legislation and with Senate Democratic Leader Chuck Schumer of New York introduced an amendment that would halt most stock buybacks and empower employees.
Warren Buffett, however, believes that stock buybacks are a good use of excess funds - only when a company doesn’t have an acquisition target and the stock is undervalued - but not as an attempt to inflate the stock price.
Time will tell who’s right, and investors do not always reveal their plans with money received from a buyback. “If the stockholders invest that money in another business or something else, that also spurs the economy,” said Greg.
Some companies have announced lay-offs and plant closures, like iconic motorcycle manufacturer Harley Davidson. This may be a defensive move: despite a healthy cut in corporate tax, companies must now compete with rising tariffs.
An international company may be able to save money with a domestic tax cut, but if these savings are reabsorbed or even dwarfed by rising tariff charges in a tit-for-tat global trade war, then companies are not encouraged to continue with domestic production.
After announcing their plant closure in Kansas City, Harley Davidson also revealed a dividend increase and stock buyback plan of around $696m on the back of the tax cuts.
Still, other companies provided bonuses to employees in the beginning of the year. The job market is strong, with unemployment holding at 4.0% in June, according to the Bureau of Labor Statistics, but strong labour demand has not translated into higher wages overall.
Wages are barely keeping pace with inflation and continue to be stagnant, which has been an issue since the Great Recession. In comparison to the money spent on stock buybacks, companies have spent a fraction on bonuses and raises - about $5.2bn.
The tax bill makes labour costs a priority for certain companies. The changes in tax law for C corps is straightforward - the rate is lower.
But, for passthrough entities like S corps, partnerships or other closely held companies, there’s a 20% deduction for income, which varies depending on the type of business and total income.
“In order to qualify at the lower rates, there’s a test based on wages,” said Greg. “There’s a provision in the law that provides incentives to companies to keep wages high, so they can qualify for the lower tax rate.”
Positive impact on the middle market
What’s happening with middle-market companies that have revenues ranging from $50m to $250m has been slightly different.
“What we’re seeing with that segment of the market is that the tax savings is spurring investment,” said Greg. Companies are taking advantage of the 100% bonus depreciation where companies can deduct the entire expense for an immediate cost recovery.
“That, in the middle market, is significant savings,” said Greg. “If I was a business owner and considered investing money in fixed assets and couldn’t afford it, now that I can write it off immediately, I’m willing to cut that expense – it’s a dollar for dollar immediate deduction.”
Manufacturers and distributors have started investing in equipment, trucks and trailers. Companies have incentives to make improvements to facilities, like installing more energy efficient lighting, for example, as these costs do not have to be depreciated.
One thing’s for sure - the fall-out from tax cuts will remain in continual motion until the long-ranging effects of tariffs and competing tax legislation are fully felt.
About the author
Andrea Murad is a New York–based writer. Having worked on both Wall Street and Main Street, she now pursues her passion for words. She covers business and finance, and her work can be found on BBC Capital, Consumers Digest, Entrepreneur.com, FOXBusiness.com, Global Finance and InstitutionalInvestor.com.