Not politics, just the facts
The Trump administration released it's high level overview of proposed tax changes on Wednesday the 26th.
There's abundant commentary available regarding the (un)desirability of the proposal as well as extensive speculation about the details which all agree were scant in the Cohn / Mnuchin presser. That's for others to debate.
This article simply takes a "from the hip" look at the potential implications of the key elements - something that boards and executive management of industrial manufacturing companies should be incorporating into scenario planning. Some of the elements would change strategies for capital equipment sales and marketing.
Of course there's a long road between this and enacted legislation and the final version could differ substantially. Further, this isn't advice - get that from your professional financial advisors!
The plan looks at individual and corporate taxes and includes some elements which aren't directly relevant to the perspective of B2B manufacturing firms. Charitable contribution and primary residence mortgage interest deductions, for instance, won't directly impact many business decisions. The key points that might, include:
- overall impact
- corporate and pass through tax rates
- territorial system & repatriation
Let's take a first stab at how each might impact capital equipment sales.
The fundamental goal of the plan is described by the administration as being to unfetter the American economic growth engine. The premise is that leaving more money in consumers' pockets, and removing disincentives to business investment, will create a broad boom.
Initially some relief/optimism would support moves that had been delayed, and as activity increased and both buzz and metrics indicated growing momentum, the trend would broaden and accelerate.
That's the most difficult to quantify, and there's hardly agreement on the premise - much less the "trickle down" elements of the proposal. Nevertheless there's little debate that in many SMBs, gut feeling and recent anecdotal / activity indicators play as strong a role in investment decisions as detailed forecasts, relative return on investment, and econometric models.
A broad growth trend would likely exacerbate the work force pressures (availability, competition & cost) which would support more interest in efficiency, increased output and automation - all factors which tend to support machinery sales.
Quick take - consumer optimism would lead to business optimism which would lead to increased investment - ergo increased capital equipment sales and shorter sales cycles
Corporate & Pass Through Rates
Many SMBs (and large companies too) are pass through structures (e.g. LLC or S Corp - profits from which flow through to the owner's personal tax return.) This means that business decisions on investment and retaining earnings are heavily influenced by personal tax rates.
It seems probable that a 15% bracket for both corporate and pass through profits would be much less likely to influence decisions around growth and investment - and could induce privately held businesses to focus less on minimizing reportable profits.
So generally that means that companies will have an easier time make financial decisions about growth and investment - including purchasing capital machinery - using a simpler set of decision criteria.
There are some caveats however.
First, the expense vs. depreciation of capital investment wasn't clarified. It had earlier been suggested that companies would be able to expense all investment (net it against profit at the time of acquisition rather than paying for it up front but only recognizing a portion of the cost against profits for each of several years depending on the investment type.)
It's naturally hard to predict how complex systems will evolve, but it's plausible that buyer negotiations will be tougher as capital tickets will be directly reflected in immediate profitability. Further, write downs on current equipment might be less desirable since their offsetting value would be diminished.
At the same time there are changes pending in lease accounting under which most leases will be recategorized as capital (essentially installment purchase) vs. operating (cost.) (Note - I was previously an advisor to, and retain a small ownership position in iLeasePro, a SaaS company with a product to help companies manage this transition.) This will have an interesting interplay with lower tax rates since the flip side to reflecting assets and liabilities on the balance sheet was the opportunity to deduct operating leases fully.
This change will likely foster increased FDI (foreign direct investment) as foreign companies are lured here by lower tax rates to manufacture here for domestic consumption as well as export to other markets.
One loser may be the IC-DISCstructure which has essentially allowed companies to pay substantially lower tax rates on profits from export sales by taxing those at a dividend rate vs. corporate or personal income rate for domestic profits. If all corporate profits are taxed at 15 or 20%, then the advantage disappears and the cost to administer would be wasted. Remember that an IC-DISC is not retroactively applicable - so if you anticipate having >$150,000 in international profits during the rest of the year, you may still benefit setting one up even if it's only useful for this year only. (Just consider when tax changes are likely to be enacted and whether they might have retroactive applicability.)
It will also be interesting to observe potential impacts on R&D. If the embedded value of expenses isn't subsidized by tax reduction, it's likely that companies will seek higher relative value from the speculative expenses they incur such as R&D.
Anticipate lots of changes based on this element - both international and interstate. Examples include:
- elimination of state tax deduction will create substantial incentive for companies to move to low tax states
- the repatriation of US corporate profits currently held overseas will likely stimulate investment
- if US companies have a very favorable domestic tax rate - and are taxed by the jurisdiction and at the rate where earnings are realized (rather than by the US at the domestic rate everywhere in the world) there will be little tax advantage to locate operations overseas or to accumulate profits in international subsidiaries. In some cases (treatment of IP) that's been a motivator - in many others the decision to manufacturer overseas has actually be more about market access. BUT, really low domestic taxes could skew the calculus and more than offset some hassle and cost associated with longer supply chains. In other words US companies might be more inclined to manufacture here and ship overseas.
- most other countries tax based on where the income is earned - that could make the US a very attractive destination for international manufacturing
Quick take - these all seem to support activity, growth and investment in the US - again seeming to support capital equipment sales.
It's not a vacuum
Of course not only will the "prime cuts" displayed during the press conference be intermixed with offal in the sausage making process of legislation, but taxes don't exist in a vacuum. A number of other high level factors bear consideration and will magnify or mute the impact of tax changes.
Statistical likelihood of a recession - we're eight years since the end of the last recession and in post war history the longest period without one has been ten years. Since 1981 the average length of expansion is eight years (which is longer than the post war period until 1981 during which they were more frequent.) Could this expansion bend the stats? Certainly. More likely, though, is a recession in the next year or two. In fact durable goods order growth is slowing and diverging from predicted trends.
Leverage - Debt is huge - personal, corporate and government. Much is carried on balance sheets (e.g. business debt reached 72.6% of GDP in 2016,) but much is not (e.g. unfunded pension liabilities which are masked with actuarial assumptions.) That substantially increases the potential impact of interest rates rising in conjunction with accelerating growth - servicing the debt load will become disproportionately more burdensome with even small changes in rates.
Geopolitics - The same day as the tax announcement the Trump administration also indicated it would not actually seek to overturn NAFTA. That follows a trend of modulating some of the more exaggerated campaign proposals and may be reassuring to some that potential instability is being reduced. Nevertheless there are security threats, and both trade and currency conflicts are likely.
Financing - There are a number of indicators that financing is increasingly difficult for SMBs to obtain. Whether due to tighter bank liquidity controls or the businesses' high debt burdens is up for debate - but if most investment will have to be funded from earnings, there will be a longer lag time and muted effect.
Revenue recognition - There are plenty of more concrete implications too. What about the revised FASB revenue recognition rules for instance? Not only how much you pay, but when you are obligated to pay the tax may well have new cash flow implications.
None of this changes the basic blocking & tackling
These are issues to think about and to build into scenario planning. They may also represent opportunities to create specific campaigns and market approaches (for instance a guide to help plant managers understand how their capex approval process may evolve.)
But none of it changes the basic work that companies should be doing to grow capital equipment sales in a consistent, deliberate, scalable way. That requires a mix of great digital marketing, revenue growth organization changes and an understanding of key global market opportunities.