What the Republican agenda on US Budget signals to treasurers.
With all the debate in the wake of House Budget Committee Chairman Paul Ryan’s proposal to cut $6.2tn in Federal spending over the next ten years, we thought it worthwhile to highlight a few areas for treasurers of multinationals to focus on.
Implications for tax reform
There will be a lot of talk going on about US tax reform with perhaps a hearing per week scheduled in each branch of Congress. However, most observers expect little chance of action until after the next presidential election. The Ryan budget proposal does little to change those expectations, but it does endorse the view that revenue neutrality requirements will limit reductions.
For example, at The NeuGroup’s Treasurers’ Group of Thirty (T30) meeting last month, Deutsche Bank Capital Markets Strategist Tom Joyce said that revenue neutrality requirements implied a 28 percent corporate tax rate floor, which remains uncompetitive. The Ryan proposal lowers that to just 25 percent. To get there, it also signals the need to eliminate tax loopholes and broaden the tax base. Indeed, right below its proposal of encouraging economic growth and job creation with a lower corporate tax rate, it proposes to:
“Remove distortions from the code by eliminating or modifying deductions, credits and special carve-outs that leave many companies paying no tax at all.”
This is not good news for many elements of treasury tax planning. The Ryan proposal does not raise expectations for a reparation tax holiday (HIA 2.0) either (see related story here). Fortunately, it does not detail deduction modifications like limits on deductibility of interest for corporate debt issues, which others have proposed. Still, by drawing the line on tax reductions where it does, the Ryan proposal leaves little room for political maneuvering to push tax rates even lower. Further, while Ryan pays lip service to an international level playing field when it comes to corporate tax policy, he does little to suggest that Republicans will push forcefully for a territorial-based tax system—unless it can be shown to be revenue neutral in a ten-year timeframe.
Implications for Financial Reform
While the Ryan proposal emphasizes its desire to end the prospect of bailouts, and their negative effects on future government spending needs, the practical impact is likely to be seen in efforts to reduce funding for the expansion of regulatory bureaucracy under Dodd-Frank. This suggests further delays in implementing the many rules left to regulators to finalize and implement by the Dodd-Frank legislation, including those involving reform of derivatives markets impacting corporate end-users.
The GSEs, which were left largely untouched by Dodd-Frank, will also see attempts for government funds to be withheld. The Ryan budget “proposes eventual elimination of Fannie Mae and Freddie Mac, winding down their government guarantee and ending taxpayer subsidies.” Along the way, it supports “increasing the guarantee fees Fannie and Freddie charge lenders in order to bring private capital back, shrinking their retained portfolios, and enacting various measures that would bring transparency and accountability to the GSEs.” It would also seek to discourage other means of shifting risk to other taxpayer-supported government entities such as the Federal Housing Administration. Bank treasurers are already faced with potential caps on the amount of Agency assets they can hold for liquidity and risk-weighted asset purposes to satisfy new bank regulations, which will already limit demand for GSE-backed MBS. The attractiveness of such assets will be further eroded as the budget debate hones in on Fannie and Freddie.
Implications for Capital Markets
It is hard to be concerned about crowding-out effects when corporate access to funding has returned to better-than-ever levels. Still, there is no question that the out-year impact of debt levels illustrated in the Ryan proposal, should it fail to stem government spending trends, would give private debt issuers pause. Plus, the capital market crises that would be unleashed in a US-led wave of serious sovereign debt concern would make the 2008 crisis seem minor. To reduce the fat-tail risk of a US default scenario alone, treasurers should welcome the spending cut debate that the Ryan proposal has set in motion.
If federal debt to GDP ratios are brought back to historical and sustainable levels, as the Ryan budget proposes, the long-term cost of capital for corporates would improve compared to the projected costs under the alternate scenario. The only question is if capital markets might fear more the near-term chance that reducing government spending too abruptly would short circuit the current recovery enough to outweigh any long-term positives.