Since the 2016 presidential election, participants in the business community have eagerly awaited the arrival of 2017, in hopes that the now Republican-controlled White House and Congress may together finally bring about comprehensive corporate tax reform. At 35.0%, the United States has the highest corporate income tax of any country in the Organisation for Economic Cooperation and Development. This can put US companies at a competitive disadvantage as most of their foreign counterparts are not required to pay the same amount in taxes to their respective countries.
However, under the Trump administration, Congress is expected to dramatically alter the US tax system.
In June 2016, Congressional Republicans released their most recent tax plan, from which IBISWorld has identified three key provisions that, if signed into law, will impact multiple US industries. These provisions include the reduction of corporate income tax to a flat 20.0%, the implementation of what is referred to as a destination-based cash flow tax (DBCFT) and the authorization for corporations to write off capital investment costs in full within their purchase year. As with any major policy change, tax code alterations will likely benefit some industries while hindering others. The following is IBISWorld’s analysis of the industries it anticipates will benefit from these potential tax changes as well as those expected to face challenges as a result.
While most industries will experience direct benefits such as higher profit margins as a result of corporate income tax reductions, others will likely experience a demand surge due to other bill provisions. For example, by permitting businesses to write off an entire major capital investment cost during the purchase year, rather than over a traditional depreciation schedule, more companies can be expected to increase their investment in areas that have lagged in recent years such as machinery, construction and research and development.
Over the five years to 2017, IBISWorld expects aggregate private investment, which measures private spending on physical structures, equipment and software, to grow at a tepid annualized rate of 2.7%. This is in stark contrast with performance during the 20-year period leading up to 2006, when aggregate private investment grew at an annualized rate of 4.8%.
Muted growth has caused domestic producers to struggle recently, even as consumer spending has continued to grow and the unemployment rate has fallen dramatically. Amid weak business spending, revenue in the machinery manufacturing sector is expected to fall at an annualized rate of 1.4% over the five years to 2017. By permitting businesses to write off the entire value of major capital investments at the time of purchase, the new tax plan would likely boost demand for machinery and industrial equipment, which would in turn benefit industries specialized in their production.
Export-oriented industries are also set to benefit under the intended policy changes. For example, by only taxing the sale of goods within the United States, the DBCFT would effectively shift the tax burden off net exporters and onto net importers. Unlike the current tax code, which taxes goods where they are produced, a destination-based cash flow tax taxes goods based on where they are consumed.
The Republicans’ tax plan is similar to a traditional Value-Added Tax (VAT) in that it taxes imports rather than exports. However, a DBCFT differs from a VAT in that it prohibits deductions for imported products, but maintains deductions for payroll expenditures, which would further benefit domestically produced goods over their foreign counterparts.
While the proposed policy is not likely to increase any given industries’ total export volume, it would increase per unit profit of each good sold abroad, boosting average profit margins. However, it remains to be seen whether or not this will enable manufacturers to lower their prices as a way to boost exports and capture a larger portion of the foreign market or drives them to reinvest these extra earnings into domestic operations.
Although the production of low-tech goods has almost entirely relocated abroad, high value-added manufacturing remains firmly rooted within the United States. As a result, by eliminating taxes on exports, such industries would stand to benefit from DBCFT, which would expand producers’ bottom lines.
For example, in 2017, the Aircraft, Engine and Parts Manufacturing industry is expected to generate nearly 60.0% of its total revenue through exports. This would be a welcomed relief for this industry, which has experienced headwinds due to the appreciating dollar over the past five years. While the tax break would not necessarily increase the quantity or value of total exports, it would increase profit margins generated from each sale made abroad. As a result, IBISWorld projects that over the five years to 2017, the trade-weighted index, which measures the strength of the US dollar relative to the currencies of its major trading partners, to increase at an annualized rate of 5.3%. This has made the price of US goods relatively more expensive for foreign consumers, hindering export growth. Consequently, industry revenue is expected to decline at an annualized rate of 1.7% over the five years 2017.
While a destination-based cash flow tax would benefit many companies, those that import nearly all of their finished goods and sell primarily to domestic markets, such as apparel retailers and consumer electronics stores, would be on the losing side of such a tax.
IBISWorld estimates that imports account for 94.9% of the computer manufacturing industry’s domestic demand in 2017. Computer sales, in turn, account for roughly 70.0% of total revenue in the Consumer Electronics Stores industry. Various other products commonly sold by US electronics retailers, such as smart phones, are also largely manufactured overseas. Since the Consumer Electronics Stores industry depends heavily on imported products, a DBCFT tax would force industry operators to either increase their prices or accept slimmer profit margins, which currently comprise a modest 4.5% of industry revenue.
The DBCFT could also adversely affect US clothing and apparel retailers, as most domestically sold clothing is manufactured overseas. Import penetration for foreign-produced clothing has gradually increased in the past decade. For example, in the Men’s and Boys’ Apparel Manufacturing industry, imports’ share of domestic demand increased from roughly 91.0% in 2007 to 97.5% in 2017.
As US clothing and apparel stores increasingly import low-cost apparel from overseas, overall clothing prices have remained relatively low, compared with other consumer products. Additionally, many clothing retailers have opened outlet stores, which sell clothing at highly discounted prices. Over the past five years, these factors have together pressured revenue in the Men’s and Women’s Clothing Stores industries. Moreover, as purchases account for more than 50.0% of each industry’s revenue, an added tax on their products would cut into their already thin profit margins.
However, while import-reliant industries could struggle under the DBCFT, the US consumer may also be negatively impacted. Despite IBISWorld’s estimate that per capita disposable income will increase an annualized 1.8% over the five years to 2022, a similar increase in the price of shoes, which is an import-intensive product, is expected during this period. Together with these factors, the implementation of the DBFCT will likely put further price pressures on the US consumer.
Although it is too early to say whether or not corporate tax reform will become a legislative reality in 2017, the ideologies around which a potential bill could be drafted have circulated for some time. Overall, the domestic business sector would stand to benefit from a simplification and reduction of the corporate tax code, enabling companies to earn higher profit margins. Furthermore, the significant tax breaks afforded to businesses that spend big on capital investments would likely increase demand for domestic machinery manufacturers.
However, the tax reform specifics would ultimately create winners and losers among industries, perhaps most starkly in regard to trade. The move toward a DBCFT would effectively shift the tax burden from net exporters to net importers, benefiting industries that sell their goods abroad, while disadvantaging those that rely on foreign products. While such provisions will likely spark fierce debate among domestic industries even before potential bill specifics are set in stone, the inclusion of a DBCFT would ultimately leave consumers paying more on a range of goods.