Corporate Taxes Fail to Follow Profit Rebound
U.S. companies such as AT&T Inc. (T) and Johnson & Johnson are paying less tax than before the recession even as profits have rebounded, buoyed by breaks and expansion in overseas markets, where the tax burden is lower.
Cash tax payments by non-financial companies in the Standard & Poor’s 500 Index (SPX) fell 13.2 percent to $222 billion in 2010 from 2007, according to data compiled by Bloomberg, while net income rose 12.5 percent to $612 billion. Cash taxes are the amount paid in taxes to all jurisdictions in a given year.
The pattern has implications for the U.S. government and for companies, said Jim Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management. With domestic job growth still anemic, Congress may want to keep tax breaks such as accelerated depreciation, while companies may continue growth outside the U.S. because of strong demand, Paulsen said.
“In this recovery, there are so much more foreign profits as a proportion of the total for the large companies,” said Paulsen, whose firm manages about $340 billion. “There are just greater business opportunities abroad with the emerging world growing faster.”
The Congressional Budget Office estimates that U.S. receipts from corporate income will drop to $181 billion in fiscal 2011 from $191 billion in 2010, and rebound to $279 billion in the fiscal year ending Sept. 30, 2012. Corporate tax collections were $353.9 billion in fiscal 2006 and $370.2 billion in fiscal 2007.
The decline since 2007 adds to the pressure on Congress as lawmakers squabble over how to narrow the U.S. budget deficits.
Offsetting Current Taxes
Some of the drop in tax receipts can be traced to the 18- month recession through June 2009 and longstanding provisions of the U.S. tax code that allow companies to use losses from lean years to offset their current taxes.
Corporate earnings also have been boosted by Congress’s move in 2008 to increase by 50 percent the amount of depreciation for capital spending that can be deducted in one year. The measure, designed to stimulate spending and create jobs, was raised to 100 percent expensing in September 2010. The accelerated depreciation write-down is set to revert to 50 percent in 2012.
“Especially for companies like AT&T and Verizon that are capital-intensive, the government put in place tax shelters in an effort to get them to accelerate some of their capital spending, and they’ve certainly benefited,” said Ben Abramovitz, an analyst with Kaufman Brothers LP in New York, who has a hold recommendation on AT&T.
AT&T posted profit of $19.9 billion in 2010 and paid cash taxes of $3.5 billion, lower than taxes of $4 billion in 2007 on net income of $12 billion.
It’s unclear how much the tax break enticed companies to boost capital spending. Companies in the S&P 500, excluding financial corporations, reported less spending in 2009 and 2010 than peak capital spending of $523 billion in 2008, according to data compiled by Bloomberg. In the past 12 months, spending has rebounded to $535 billion.
“It’s really in the best interest of the economy for the U.S. government to entice those companies to spend on something that creates a long-term economic benefit and that primarily is infrastructure in the country,” Abramovitz said.
Dallas-based AT&T’s capital expenditures fell in 2009 to $16.6 billion from $19.7 billion the previous year. Spending rebounded to $19.5 billion in 2010 and is forecast to reach $20.1 billion this year for the second-largest U.S. wireless provider and largest U.S. telephone company, according to the average estimate from 17 analysts surveyed by Bloomberg.
The effect of net losses on cash taxes can linger for years because companies can gradually deduct them from subsequent profits, said Michelle Hanlon, associate professor of accounting at the Sloan School of Management at the Massachusetts Institute of Technology in Cambridge.
After eliminating non-financial companies that had losses in 2008 and 2009, cash taxes for S&P 500 members fell to $200 billion in 2010 from $217 billion three years earlier. Profit in those periods rose to $547 billion from $512 billion, according to the data compiled by Bloomberg.
Johnson & Johnson (JNJ)’s cash tax bill dropped to $2.4 billion last year from $4.1 billion in 2007 while net income rose to $12.3 billion from $10.6 billion. Part of the reason for the reduced tax bill of the world’s second-biggest seller of health products is expansion in countries such as China, Brazil and India, where the corporate tax rate is lower than the U.S., said Jeff Jonas, an analyst with Gabelli & Co. in Rye, New York.
Growth Outside U.S.
“The bulk of their growth has come outside of the U.S.,” said Jonas, who has a buy recommendation on New Brunswick, New Jersey-based J&J. “They really stepped up their investment in emerging markets.”
Profits earned abroad are levied at rates in those jurisdictions, with a credit given for foreign taxes paid, and aren’t subject to U.S. taxes until brought home.
At Danaher Corp. (DHR), a maker of medical and measurement equipment, the percentage of revenue from emerging markets jumped to 22 percent from 10 percent in 2005. That share may climb to 40 percent over time, Chief Executive Officer Larry Culp said in a Nov. 8 presentation to analysts.
“Companies are even more aggressive in terms of identifying the countries in which they earn the income,” said Robert Willens, a corporate tax consultant in New York. “They’re able to shift more profits to tax haven kind of countries that have lower rates.”
Bringing Profits Home
The catch is that multinational companies can’t repatriate those profits to the U.S. without paying corporate tax on them. With a top corporate U.S. rate of 35 percent, cash held abroad has been piling up. About $20 billion of Johnson & Johnson’s $31 billion in cash and short-term investments is held outside the U.S., Jonas said.
U.S. companies, including Microsoft Corp. (MSFT) and Oracle Corp. (ORCL), are pushing for a tax break to repatriate more than $1 trillion of earnings held abroad. Microsoft CEO Steve Ballmer and Oracle Co-President Safra Catz were among 15 executives who signed a letter to congressional leaders to urge a tax holiday on overseas income, which would “immediately inject significant private-sector investment” into the economy.
Congress in 2004 temporarily reduced taxes on overseas profits to 5.25 percent to spur companies to repatriate cash. Johnson & Johnson would jump at a repeat of that offer, Jonas said.
“Because of all these strategies and all their international growth, the bulk of their cash is outside of the U.S., and they’d be more than happy to bring it back at a 5 or 8 percent tax rate,” he said. “They’re not willing to bring it back at a 35 percent rate.”
Tax Code Overhaul
The incentive companies have to invest overseas underscores the need for a U.S. tax-code overhaul that would lower corporate rates, said Gary Flam, who helps manage $6.5 billion for Bel Air Investment Advisors LLC in Los Angeles. Investors cheer lower cash taxes, he said.
“It means there’s more cash flow for investors,” Flam said. “As shareholders, from a capitalistic standpoint, you want your companies to maximize cash flow because that’s how you maximize value.”