The taxman and the investor

We may have seen the end of a trend. Since the Beatle song from 1966, Taxman, which was a lament about high taxes, tax rates have gone down quite a bit all over the world, especially for companies. It seems like things are changing now. What does that mean for investors?

First, a word about why rates had fallen so much. Tax competition between countries plays an important role in this. With lower rates you can lure companies and still fill the treasury better. Although these are real dollars or euros for the treasury, they do not usually attract real economic activity. The main result is that multinationals use all sorts of clever tricks to ensure that profits are low in countries with high rates (and vice versa).  

There was growing international criticism of this economic sham. It pushes profit taxes ever lower, because otherwise companies - or their paper profits - will move. Evaders also undermine the tax morale of those who do pay the full amount. Ultimately, these tax tricks create all sorts of distortions, because governments have to get the resources from somewhere else. Then you get higher taxes on labor, for example - because workers are simply less transient - and that costs jobs.

Especially now that Covid and climate ambitions are putting a hefty strain on budgets, additional tax revenues are welcome - including in the US. This is one of the driving forces behind the G7 proposal for a minimum profit tax of 15%. This proposal - which is still a long way off - would provide governments with direct money and could stop the race to the bottom.

Judging by some initial estimates, governments would rake in billions of dollars from this, as much as some 10% of profits in the coming years. Now it is no news that investors would rather see more profits than less. Still, we think you need to look beyond the immediate effects here. The proposal allows for less distorting taxation, which promotes economic growth. This is true even if the extra revenue goes to smart public investments that promote productivity and support profit growth.  In addition, investors look not only at returns, but also at risk. More inclusive economic growth - with a reasonable division between labor and capital - could also lead to a more stable economic environment, i.e. fewer trade wars or "yellow jackets.”

In short, you can't just say that higher profit taxes are bad for companies and therefore for stock returns. Yes, every euro that goes into the treasury cannot be paid out in dividends. But as mentioned, for those euros you can also get something back in the long run: calmer waters. In the past, tax increases - or announcements of them - have also had little effect on equity markets.  By the way, let's not forget another cornerstone in pension portfolios - bonds. In that sense, it is good for governments to have a solid tax base.

Is the tax pendulum swinging back now? In any case, it seems that the race to the bottom is nearing its end. Governments initially allowed their own space to be curtailed by the market, but they are now taking a more dominant role themselves. Yet the reverse, a race to the top, will not happen overnight. The taxman that George Harrison complained about used a "supertax" of 95% - "one for you, nineteen for me". The Beatles almost went bankrupt because of it. Things will not be as bad now. There are many good reasons to play the Taxman track, but for the time being economic news is not one of them. And for investors, it won't be so bad.

Charles Kalshoven is a macro-economist and senior strategist at APG