The key is the size of the deductions a sector currently enjoys.
In the give and take of Washington, politicians seeking corporate tax cuts may have to agree to a significant reduction in corporate deductions and tax credits to reach a deal. While some Tea Party members on Capitol Hill say closing loopholes amounts to a tax increase, and is therefore unacceptable, there’s a chance that such measures will be part of a deal, either during the debt limit standoff or during the next round of budget talks.
Fitch Ratings says a package including a flat 25 percent tax rate along with aggressive loophole closure would be of most benefit to the retail sector, while battering some parts of the energy business.
In its June 22 report, US Tax Reform Impact on Corporate Issuers, Fitch examined the effects of both a 25 percent rate applied only within the US jurisdiction and one applied to all income generated worldwide. It compared these to the current tax regime, where all income worldwide is taxed, but taxes on overseas income are deferred until repatriation.
A territorial approach can be attractive if a MNC generates a lot of income in lower-tax countries, such as Switzerland or Ireland, but provides little incentive for repatriating intellectual property. The worldwide approach, meanwhile, could spur companies to reincorporate in a more tax-friendly country, according to Fitch.
Telecom companies are the worst off under a worldwide 25 percent flat tax rate, before deductions, seeing their levies rise from a five-year average cash tax rate of 18.3 percent. But when deductions are eliminated, and items such as the SuperFund Tax are put in the mix, energy companies become the worst-off sector. For example, a 25 percent flat tax and the repeal of LIFO would cause a decline of 28.3 percent in free cash flow for the global independents category, followed closely by drillers, US independents and integrated energy companies.
The same scenario increases the retail sector’s free cash flow by 25.3 percent, Fitch estimates. This is because it has paid some of the highest cash tax rates over the past five years (an average of 35 percent) and has had little in the way of tax credits.
In fact, seven of the 17 sectors Fitch analyzed would see an increase in free cash flow. Along with retail, these are:
- Food and Tobacco (18.6 percent)
- Consumer (13.2 percent)
- Energy – Refiners (10.8 percent)
- Healthcare (7.5 percent)
- Building and Materials (7.0 percent)
- Media (5.0 percent)
For these sectors, the benefit of the tax reduction outweighs the cost of closing loopholes. In fact, if one excludes energy sectors, the total effect on the remaining sectors is slightly positive – 0.3 percent – a number corporate lobbyists should bear in mind.