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High Tax Rates Stop Corporations from Moving Back to America
Hot Topic: Can We Bring Back Corporations?
Many multinational corporations have moved their headquarters overseas to avoid high corporation tax rates and seek cheaper labor for more profit. Consequently, more and more jobs have been outsourced. Americans need jobs. How to bring back jobs has become a hot topic for the coming Presidential Election. If multinational corporations could move their headquarters back to America, there would be an increase in the labor market. It would also stimulate the United States economy. The question has become what stops corporations moving back to America? Although the Government wants multinational corporations to be incorporated in America, shareholders and corporations prefer to stay overseas for benefits and profitability.
We Want Them Return, But How?
The U.S. Government Wants Corporations to Be Incorporated in America
Multinational corporations are driven by profit. High tax rates mean they have more expenses, which reduce their net income. Thus, their profitability is reduced. CNN journalist Sahadi (2014) indicated: “the U.S. has the highest tax rate among developed economies,” and “most U.S. corporate income is subject to 35% federal tax rate.” Ireland, in contrast, has a tax rate of only 12.5%. Suppose a corporation has $100 billion operating income before tax. The corporation needs to pay $35 billion of federal income taxes in the United States. Comparing a payment of $12.5 billion in Ireland, the corporation saves $22.5 billion that could be used to expand business or distributed to shareholders as dividends.
Furthermore, our Government is in deficit every year. Sahadi (2014) also pointed out “corporation tax revenue accounted for 10% of all federal tax revenue.” Therefore, it is impossible to reduce corporation tax rates. Reducing tax rates means reducing federal tax revenue, resulting in more debt for our Government. As a matter of fact, the U.S. corporation tax rates have not changed for years. In the first Presidential Debate from Hofstra University, Republican candidate Donald Trump indicated he plans to reduce corporation tax rates to 15% (Full video: watch the Trump-Clinton Debate from Sept. 26, 2016). In that case, multinational corporations could return to America; however, Democratic candidate Hillary Clinton argued the plan would create $5 trillion debt for the Government (Full video: watch the Trump-Clinton Debate from Sept. 26, 2016). Our Government is already deeply in debt. If another $5 trillion debt is added, our Government could go bankrupt, which might cause another major economic recession globally.
It Is Not the Problem Only for the United States
Shareholders Do Not Want Corporations to Move Back
Shareholders are the investors of corporations. If shareholders expect a corporation to remain profitable in the future, they will invest money to buy the corporation’s stocks, hold them for dividends, and sell them at a higher price to make profit. They expect the corporation in which they invested to be profitable, so they can earn returns on their investment. In contrast, if shareholders lose confidence in a corporation, they will not hold the corporation’s stocks. They sell the stocks as soon as possible. Consequently, the stocks’ price drops because there are too many shares in the market that no one wants to buy.
Three equations explain the relationship between corporation tax rates and stock price:
- Net Income = Revenues – Expenses
- Earnings Per Share = (Net Income - Preferred Stocks) / Weighted-Average Number of Common Shares Outstanding
- Stock Price = Earnings Per Share X Price Earnings Ratio
From equation 1, high tax rates mean more expenses that reduce net income. From equation 2, Earnings Per Share (EPS) equals net income divided by weighted-average number of common shares outstanding, ignoring the influences of preferred stocks. Therefore, decreasing net income decreases EPS. From equation 3, Stock Price approximately equals EPS times Price Earnings Ratio (P/E). P/E ratio is a leverage ratio that predicts how well the corporation will perform in the future as estimated by shareholders. Supposing the P/E ratio stays the same at the beginning, decreasing EPS causes the stock price to drop directly. To make things worse, shareholders start to feel less confidence in the corporation because of the drop of stock price; therefore, the P/E ratio starts to decrease. Shareholders would rush to sell the stocks because the price would become even lower. Thus, the stock price would drop more rapidly.
Major shareholders know the serious consequences; therefore, they want to prevent the situation from happening and secure their investments. They have huge influence on the board of the directors who were chosen by shareholders to represent the shareholders. They would use their voting rights to veto the decision to move back to America. If corporations insist on moving back, major shareholders might also sell stocks they owned, resulting in even more damage to the corporation.
Multinational Corporations Also Do Not Want to Move Back
Corporations seek every opportunity to increase profitability by reducing unnecessary cost. The New York Times journalist Wayne (2012) wrote: “half of all public corporations in the United State are incorporated in Delaware,” and “Delaware is a great place to reduce tax bill…an arrangement is known as ‘the Delaware loophole’ has enabled corporations to reduce the taxes paid to other states by an estimated $9.5 billion” in 2011. Incorporating overseas gives corporations a much lower tax bill, so they can make more profits.
High tax rates in the United States also reduce corporations’ financing ability. Many corporations purchase assets or acquire other corporations by using equity financing. Instead of borrowing money from banks, corporations issue their stocks to sellers, so they can avoid interest expenses on financing. Therefore, stock price becomes extremely important. If the stock price drops, sellers would not accept the corporation’s stocks. Consequently, the corporation will not be able to use equity financing. They could only go to banks and borrow money for which they must pay interests. To keep their financing abilities, corporations will not pass any decision to hurt their stock prices.
Many C-level executives are paid with compensation packages. Stock option is one of the most common benefits included in the compensation packages, and it ensures that executives will buy the company’s stock at exercise price. If the company’s stock price rises above the exercise price, executives can exercise their stock options and make profits. If corporations move their headquarters back to the United States, the stock price might drop because of the profitability, which means executives could not exercise their stock options to make profits.
Conclusion: Multinational Corporations and Their Shareholders Are Not Willing to Move Back to America
The United States Government wants corporations to be incorporated at the U.S. mainland for increasing job opportunities and stimulating economy. The key for corporations to return America is lowering corporation tax rates. The United States needs a plan to reduce corporation tax rates without increasing the debt of the Government.
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Can G20 Meeting Make Any Difference?
Full video: watch the Trump-Clinton debate from Sept. 26. (2016, September 25). Election Central. Retrieved from: http://www.uspresidentialelectionnews.com/2016/09/full-video-watch-the-trump-clinton-debate-from-sept-26/
Sahadi, J. (2014, August 14). 7 things you absolutely must know about corporate taxes. CNNMoney. Retrieved from: http://money.cnn.com/2014/08/14/news/economy/corporate-taxes-inversion/
Wayne, L. (2012, June 30). How Delaware thrives as a corporate tax haven. The New York Times. Retrieved from: http://www.nytimes.com/2012/07/01/business/how-delaware-thrives-as-a-corporate-tax-haven.html?_r=1