Taxes. Everyone hates them, and no one wants to see them move any higher. They’re the universal burden that is just slightly less ominous than death. That’s why when the recently reinvigorated Trump tax plan was thrown into the mix, Americans rejoiced — perhaps even the ones that absolutely hate the President.
The biggest impact of the Trump tax plan is towards the corporate tax rate. At 35%, conservative politicians have criticized that we have the most onerous taxes among western and developed nations. President Trump proposes to reduce this rate down to 20%, which in theory unleashes the American economic engine. More companies have more cash, which in turn, they use to hire more people.
Strangely enough, hedge-fund managers are one of the biggest supporters of the Trump tax plan. This is because activist managers often apply pressure on companies to do something with their cash reserves, usually in the form of stock buybacks or special dividends. If the corporate tax rate is reduced, that should leave more companies cash-rich, and thus subject to fund-manager pressure.
If only it were that simple. The Trump tax plan will impact some companies, but it will not engineer the economic renaissance that proponents expect. While our corporate tax rate is among the highest in the developed world, our effective tax rate is not.
That is, the corporate tax is the stated tax. It’s the rate companies would pay if they had no deductions and expenses to lower their taxable income. However, every entity has deductions — some more than others. The net tax is the effective tax rate, or what you actually pay Uncle Sam. That figure is almost always lower than the stated corporate tax rate.
Indeed, the Trump tax plan may have an unintended consequence. If the corporate tax rate is lowered to 20%, some companies whose effective tax rates are higher than that would lack the incentive to generate deduction-incurring business activities. Why bother “forcing” yourself to hire another employee simply to achieve lower tax liabilities when you can save your money and still enjoy a low rate thanks to the Trump tax plan?
Of course, the reason why such proposals are forwarded is for political gain. It simply reads better when you can get up on a podium and declare that you sparked economic growth through lower taxes. Behind the scenes, the reality of the effective tax rate may mean that nothing substantive occurred.
But the American public loves a good story, even if it’s not real.