Jack Ablin Market Update

Over the years, Americans have migrated from the North and East to the South and West as they put away their business attire, both blue and white collar, and kicked up their heels in retirement. These newly minted pensioners are attracted to better weather, a slower lifestyle and a cheaper cost of living.  High-tax states have lost out to low-tax states as a result of migration trends. Those trends accelerated in 2020: according to US Census data, states like California, New York and Connecticut, which rank in the two highest quintiles by tax burden according to the Tax Foundation, collectively lost 240,000 residents last year while states like Arizona, Florida and Texas, in the two lowest tax burden quintiles, expanded by more than 1.2 million. It’s a race to the bottom in which high-tax states are losing out to lower-tax states, particularly in a post-pandemic, remote-work economy.

New York exemplifies the challenge. In a state already hit hard by the pandemic and the 2017 SALT deduction caps, lawmakers have recently agreed to increase taxes on high-income residents while boosting franchise taxes on local corporations. Under the plan, income tax rates will rise to 9.65 per cent from 8.82 per cent for individuals earning more than $1 million. Income over $5 million would be taxed at 10.3 per cent and income greater than $25 million at 10.9 per cent. The move could backfire, accelerating the trend of individuals and corporations exiting the state. Already, Elliott Management, Icahn Enterprises, Blackstone Group and Moelis & Company are among the firms that have either moved their headquarters or opened new offices in Florida, according to The Wall Street Journal. New York City-based Goldman Sachs Asset Management is considering relocating a portion of their business and moving as many as 100 employees to West Palm Beach, Florida. Since 2016, New York has bid farewell to an increasing number of former New Yorkers. The state suffered the worst population loss of any in the union between July 2019 and July 2020. That trend could accelerate, as companies appear to be increasingly willing to relocate their headquarters and transplant their employees.

Many of the same dynamics occurring at the state level are also taking place internationally – not necessarily with high high-net-worth individuals, but with multinational corporations. Such firms, particularly in the tech or pharmaceutical sectors and who have made substantial intellectual property investments, have had the ability to play one tax jurisdiction against another and have been doing so for years. The US corporate tax rate, which KPMG puts at 27 per cent (including state and local taxes), has put the country at a competitive disadvantage relative to tax havens, like Ireland at just 12.5 per cent, Singapore at 17 per cent and Hong Kong at 16.5 per cent. While the US has reduced its corporate rate in recent years, overseas rates have fallen even faster. President Trump’s 2017 corporate tax reform bill was an attempt to level the playing field. Nonetheless, corporate investments have continued to flow into low-tax jurisdictions like Singapore and Hong Kong (Ireland is a current exception, because it is embroiled in Brexit).

Industry trends could upend President Biden’s plan to raise the corporate tax rate as part of his enormous infrastructure initiative. The United States risks prompting a profit outflow similar to what New York is experiencing with its taxpayers. Stemming that tide is the motivation behind Treasury Secretary Yellen’s effort to seek global cooperation in setting corporate tax rates and reduce tax avoidance by pharmaceutical companies and big tech. The plan seeks to set a global minimum tax rate to prevent companies from shifting profits overseas. Such a tax, in her words, would stop the “race to the bottom” that has been ongoing for decades.

Under the Trump administration, the corporate tax rate was cut from 35 per cent to 21 per cent to try to make the US more competitive with the rest of the developed world. The legislation also created a minimum tax of 10.5 per cent on US companies’ foreign income. Prior to that legislation, the US had assessed the world’s highest effective corporate tax rate for more than a decade.  President Biden wants to raise the rate to 28 per cent and increase the international tax rate Americans pay on their foreign profits to 21 per cent. At the same time, the administration needs to make the United States an attractive place to re-shore manufacturing capabilities. A report in The New York Times indicated that the Organization of Economic Cooperation and Development (OECD) has been working to develop a new international tax code that would include a global minimum tax rate for multinational corporations to stem the erosion of corporate tax revenues.

In our view, it’s unlikely the plan will work. The global corporate tax initiative is targeted at fewer than 100 technology and pharmaceutical companies which have operations globally and have housed their intellectual property, be it drug formulations or software, in tax-friendly territories. Policymakers believe their profit margins are excessive. Many of the European old guard favor a tax program targeting technology companies, most of which are American. But getting the tax havens like Singapore, Hong Kong and Ireland to go along with the plan is remote, given how much their economies benefit from foreign corporate inflows. The biggest debate centers around international taxation philosophy: whether to tax companies based on where they generate income or based on the country in which their headquarters reside. The tax reform act of 2017 didn’t address that issue then, and it is unclear how international negotiations would resolve it now. Besides, corporate tax collections barely move the revenue needle in Washington anyway: they comprise just over 1 per cent of GDP, down from 6 per cent in the 1950s. Rather that hold the line on global tax havens, lawmakers should make America a tax haven and slash the corporate tax rate. Any shortfalls could be made up through the additional personal income tax collection that would organically arise from the economic growth and good-paying jobs that would return to our country.