The Daily Update - Budget, tax reform and Apple

Congress should shortly pass a bill to temporarily circumvent the debt ceiling. Subsequently, they will deal with the budget, which is very likely to be late. Tax reform, like the repeal of Obamacare, is much too complicated to get done anytime soon, so the budget could be in limbo for the rest of the year. Or Congress would have to pass something that did not incorporate tax reform. The problem is that the Republicans, despite having control of Congress for many years, currently have no viable plans either for health care or tax reform.

The Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) released a report in July that does not expect the President’s Budget to achieve a surplus in the next 10 years, yet the President’s Budget is aiming to reach a balance by 2027. Nearly all of the difference stems from the revenue assumptions: the CBO include lower economic growth expectations reflecting a lack of policy detail (e.g. tax reform) which means they incorporate less for macroeconomic feedback effects and fiscal multipliers. According to CBO estimates, Trump’s proposals will generate an extra 0.1% of growth per annum over the 2018-2027 period when the Trump Administration is talking of an additional 1%. Already one can see that there are a lot of moot points.

Trump has spoken of a 15 percent target for the US corporate tax rate and the scope to make the US tax system more efficient and competitive. While removing inefficiencies and lowering the overall tax rate seems desirable the issue is complicated and not helped by numerous loopholes. The Congressional Budget Office noted in a March 2017 comparison of corporate tax rates for 2012: using the top rate of statutory tax the US is the highest among the G20 nations at 39.1% (including state taxes). When they looked at the average corporate tax rate (corporate tax as a percentage of income) the US at 29% is third highest amongst the G20. Using their estimate the effective marginal corporate tax rate is 18.6% (the tax burden on returns from marginal investment) and the fourth highest rate among the G20.  Nevertheless, the ranking does suggest there is scope for improvement; but as the Congressional Research Service notes ‘The statutory rate differential is relevant for international profit shifting; effective rates are more relevant for firms’ investment levels.’

Trump is keen to address the repatriation of international profits which face a tax rate of 39.1% (Federal and State taxes) less any tax credits for taxes already paid overseas: ‘By making it less punitive for companies to bring back this money, and by making the process far less bureaucratic and difficult, we can return trillions and trillions of dollars to our economy and spur billions of dollars in new investments in our struggling communities and throughout our nation.’ Estimates vary about the actual size of the cash pool US corporates are holding offshore.  For example, Moody’s estimate that at the end of 2016 USD1.84tn of cash was held by US non-financial corporates and USD1.3bn was held overseas. Trump has talked of a much larger figure, ‘anywhere between $3tn to $5tn’, but the White House cites a figure of USD2.6tn for Fortune 500 companies holding profits offshore.

Apple perhaps epitomises some of the inefficiencies the US tax system is creating.  Tim Cook, the CEO of Apple, is reported as saying ‘The issue is not that there's a tax on international earnings. The issue is the existing tax has been crazy,’ and that ‘No one would bring it back at a 40 percent—I mean, 35 percent federal and then state taxes. That's the problem. I think it's smart for the United States to have some kind of tax revenue for international earnings—if that tax were reasonable.’ S&P estimated that Apple had USD17bn of domestic cash at the end of the second quarter and expect it to continue to tap debt markets while there are no reforms making it more attractive to repatriate overseas cash. S&P estimates the total net cash position of Apple was much higher at USD158bn.

Unsurprisingly, Apple returned to the debt markets this week with a USD5bn bond issue at 2, 5, 10 and 30 year maturities to finance its share buyback program and fund dividend payments. On a positive note, these inefficiencies in the tax system are creating some good opportunities for us to gain exposure to corporate credits. Apple is rated Aa1/AA+ by Moody’s and S&P and some of the existing issues screen attractively on our models. For example, Apple 3.85% 2043 is a liquid USD3bn issue and trades 4 credit notches cheap on our models.