Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Wall Street is getting excited now that Congress seems ready to tackle the issue that it's been most eager for: corporate tax cuts.

On Wednesday, President Donald Trump is unveiling a more concrete outline for his proposal that would lower company tax rates to 20 percent, down from the current 35 percent, among other measures, three people familiar with the plan told Bloomberg News.

Traders are expecting companies to invest more, leading to faster growth and higher bond yields. Indeed, U.S. government bonds sold off Wednesday just on the thought that a tax plan was in the works. But they may be getting ahead of themselves.

Rising Rates
Benchmark borrowing costs rose Wednesday as expectations mounted for corporate tax cuts
Source: Bloomberg

First, a great deal of uncertainty still clouds whether Republicans can coalesce around a concrete plan and move it forward quickly. Second, the ramifications of these tax changes may be somewhat unexpected.

Let's consider one of the biggest issues under discussion. Trump has talked again and again about the trillions of dollars of cash that big U.S. corporations are holding overseas that he wants to bring home, creating jobs and fostering economic growth.

Under current proposals, some are expecting Congress to lower the repatriation tax rate to 10 percent, down from the current rate of more than 30 percent. It's unclear whether this would be enough to prod companies to bring the money back because 10 percent is still more than the average 3.2 percent rate that big investment-grade companies are paying to borrow money in the bond market.

If corporations do transfer cash back to the U.S., it may not go where lawmakers think it will. To the extent that companies have wanted to build plants or hire more people, they could have already done so. Companies like Apple Inc. and Microsoft Corp. have effectively brought money back home by simply selling dollar-denominated bonds and using the proceeds to execute their grand plans.

Borrowing Binge
Apple had no debt in early 2013, and now its borrowings stand at more than $100 billion
Source: Bloomberg
Note: The quarters shown here reflect Apple's fiscal year, which ends each September.

What have those grand plans been? Largely buying back shares. This has certainly supported stock valuations, but it hasn't delivered an obvious boost to Main Street America.

More likely, companies like Apple and Microsoft would most likely buy back at least some of the billions of dollars of bonds they've issued, reducing debt that was incurred almost entirely to get around the onerous tax rates. This would actually help boost the values of these bonds because it would send money back to investment firms, which would be forced to redeploy it.

Debt Load
Microsoft has sold tons of debt recently, in large part to buy back shares and pay dividends
Source: Bloomberg, SEC filings

Meanwhile, Congress hasn't outlined a way to pay for these tax cuts, which points to higher budget deficits going forward, which may very well slow growth, not accelerate it.

There's also a belief that tax policies will strip away the advantage companies now have with selling bonds, namely that they can deduct the interest payments from their taxes. This would also prompt companies to buy back outstanding bonds, particularly those with very long maturities, as Bank of America Corp. analysts noted in a report on Tuesday.

As we get closer to actually seeing the holy grail of 2017 for U.S. markets -- a comprehensive plan to cut corporate taxes -- the market's response may be substantially different from what many are expecting. The reality is there's plenty of money in the financial system, including at the big companies that are poised to get a boost. Corporate bond valuations may benefit more than the American economy.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net