A stock market wild card in 2017 is the potential for a significant reduction in the corporate tax rate. President-elect Trump’s desire to lower corporate taxes, if implemented, would have multifaceted impacts on businesses. Lowering the corporate tax rate from 35% to as little as the proposed 15% rate would be a historical cut, not only due to the size of reduction, but also because it will be the first corporate tax rate cut since 1988. The ultimate shape and size of corporate tax relief can only be surmised at this point, but we can begin to gauge the impact on corporate earnings using a few simplified assumptions.
Corporate earnings drive stock prices, and a meaningful lowering of tax expense could have a significant impact on EPS growth over the next couple of years. This analysis examines corporate tax expense as represented by the 500 largest U.S. companies, and discusses how—and to what degree—the lower statutory corporate tax rate could impact reported earnings. (In our next report we’ll look at another important piece of Trump’s tax plan: tax on cash repatriated from overseas.)
Declining Effective Corporate Tax Rate Is Still Well Above 15%
The U.S. has one of the highest statutory corporate tax rates in the world, yet we find that companies are increasingly using sophisticated tax management schemes to reduce their effective rate (defined as income statement tax expense divided by pre-tax income). A tally of the largest 500 companies with three consecutive years of positive taxable income (excluding REITS and MLPs) finds that indeed the average effective tax rate (including federal and state tax payments) has declined from above 35% in 2002 to 29% currently.
While companies have undercut the statutory rate by six percentage points, tax payments are still well above Trump’s proposed 15% federal tax rate. Assuming an average state tax around 4%, the tax rate including federal and state could be capped at around 19% based on Trump’s most aggressive plan. On average, this reduces companies’ tax rates by one-third. Actual savings, however, will vary.
Tax Savings Varies Among Sectors
Companies with high effective tax rates would generally reap the most benefit of Trump’s tax plan. We quantified the difference in tax savings at the company level under three scenarios: assuming a federal rate at 15%, 20%, and 25%, with a flat state tax rate at 4% (the 4% state tax rate is an average; applying it to all companies can give us only a rough calculation). The 500 companies that make up our sample universe experience noticeably different tax savings depending on their sector membership.
A dramatic cut in the statutory rate should benefit sectors currently paying the highest effective rate. Table 1 measures this impact by calculating: (1) the total tax paid by sector; (2) the total reduction in tax expense under the three scenarios; and, (3) the scale of this tax reduction as a percent of tax expense. Among the ten sectors, Utilities, Telecom Services, and Consumer Discretionary currently have the highest median effective tax rate. Technology, Health Care, and Energy post the lowest rates.