Thoughts on Corporate Tax Reform

I’ve spent some time thinking about Trump’s proposed tax cuts for corporations and I’m curious as to who will ultimately benefit from them. I should start by saying that I believe the beneficiaries of the tax cuts will vary across companies and industries. Here are my thoughts.

For the most part, I don’t think lower corporate tax rates will end up in the pockets of the owners of companies, except in certain circumstances. The exception, which I will touch on later, will be businesses that have pricing power.

Let’s think of businesses like Walmart and Amazon who strive to be low cost operators. If Walmart looks to earn an after-tax net margin of 3% at a 35% tax rate, it will just as easily accept a 3% margin at a 15% tax rate and quite possibly reduce revenues, i.e., prices will decrease for consumers. I would agree that after-tax net margin might not be an explicit goal for Walmart, but I would comfortably assume that all of its corporate goals in some way lead to that number. Walmart’s mission is to provide low prices on a very large scale, and a lower tax rate will allow it to decrease prices while maintaining the same profitability. Amazon will most likely do the same thing.

Both could also demand lower prices from suppliers, being that they both have extensive buying power and suppliers will have lower costs because of the tax cuts. Basically, in businesses where the companies compete mainly on price, the benefits will be diffuse and mainly fall to the customer, not the company or its owners. This would suggest that corporate tax cuts could benefit consumers in a lot of cases.

On the flip side are companies like Apple, which have significant pricing power. In the case of Apple, lower tax rates will most likely not cause it to reduce prices to compete, and the lower tax rates will fall mainly to its bottom line.

In most cases, the answer probably isn’t as clear cut, and even in the cases I’ve outlined above, it’s not clear cut. I would say that in the majority of cases, some of the benefits of the corporate tax cuts will go to the corporations and its owners and some of the benefits will go to the customers of the corporation. It will be interesting to see the results, because the lower taxes will affect all corporations, but those who benefit in each case could vary greatly.

Another likely scenario could be higher wages for employees at some corporations, which will neither change the top line nor the bottom line. If revenue and net income stayed the same after the tax cuts, it would suggest that this hypothetical company absorbed the tax cut and increased its wages. Of course, wages aren’t the only cost that could increase. I could see this happening in the banking industry, where pricing competition exists but is muted, so customers won’t necessarily benefit and the industry dynamic seems to be that many of the benefits go to the employees and not necessarily the owners of the companies.

I’m interested to see how companies react to the much lower tax rates, as I think it will shed some light on various industry dynamics. I’m not stating that I’m either for or against the proposed new tax rates, but being able to observe how various companies react to the new rates would be quite interesting.

Disclaimer: I/we have no investments in the companies mentioned in this post and do not plan to purchase any of these companies within the next week. However, over the next three months, I/we may purchase any of the businesses mentioned in this post.

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