Last Week in US Debt and Global Taxes

Editors’ note: MarketMinder is nonpartisan, preferring no party nor any politician. Our analysis serves solely to ascertain government actions’ potential market impact—or lack thereof.

Last Thursday, two political measures commentators we follow have been closely watching took steps forward: In America, Congress advanced a measure to raise the debt limit, whilst Ireland signed on to the US-backed global minimum corporate tax deal. Here we will bring you up to speed on these matters—and put them in broader perspective.

US Congress’s teensy debt-ceiling increase: Last Wednesday, the Republican Party’s leader in the Senate helped clear the way for Democrats to pass a standalone debt limit extension, which commentators we follow had been warning for weeks would trigger calamity. As his statement noted, he would “allow Democrats to use normal procedures to pass an emergency debt limit extension at a fixed dollar amount to cover current spending levels into December.”^[i] In other words, he wouldn’t use the minority party’s statutory powers to delay a vote on a bill to raise the debt ceiling a smidge.

Legislation is now progressing to increase the debt limit by $480 billion to $28.9 trillion, passing the Senate in a 50 – 48 party-line vote Friday.^[ii] A House vote is expected this week.^[iii] If it passes, the US Treasury estimates it should let the government finance spending through early December. Then, America might face another standoff. If so, remember:

1. Default risk was always next to zero, according to our analysis. Default doesn’t mean skipping spending. It means failing to pay interest or principal on sovereign debt. Our research shows the US Treasury has the means (tax revenue) and the motive (a constitutional mandate) to service the debt. We think the likelihood of default was and remains miniscule.
2. America’s politicians have a long history of preaching debt ceiling calamity, then raising the limit at the eleventh hour. The heightened rhetoric is largely business as usual and hasn’t historically prevented Congress from enacting a solution.

136 countries’ corporate tax compromise: In other news, the global minimum corporate tax we discussed in June took a step forward last week. The plan seeks to establish a 15% minimum tax rate on multinationals’ profits where they are earned, not where they are headquartered.^[iv] The main problem with this scheme, in our view: Tax havens stood to undermine the initiative—including Ireland, where many multinationals have flocked, and fellow EU members Estonia and Hungary—by refusing to sign on and undercutting the global minimum rate. For months, news coverage we follow reported these nations have expressed reservations about the deal, which would see Ireland raise its headline corporate tax rate from 12.5% to 15.0%.

But Ireland and Estonia dropped their opposition Thursday after countries already party to the deal made concessions.^[v] Hungary followed Friday.^[vi] Ireland received assurances it can keep its 12.5% tax rate for firms with less than €750 million in annual sales and tax incentives for research and development.^[vii] It also succeeded in revising the original text. Instead of it stipulating a minimum tax of “at least 15%,” it now omits “at least,” making future attempts to raise it likely very difficult.

Hungary joined after negotiators agreed to a 10-year implementation period before the tax takes effect and the ability for companies to deduct some costs, including payroll.^[viii] Some other developing nations are still outstanding—Kenya, Nigeria, Pakistan and Sri Lanka.^[ix] But the 136 countries that have signed on account for the vast majority of global GDP.^[x]

Whilst Ireland, Estonia and Hungary coming into the fold is notable, we think there remains a long row to hoe. Countries must still pass legislation for enactment, which isn’t assured, in our view. For example, our analysis suggests the US Congress probably needs bipartisan support to give foreign governments jurisdiction to tax American companies. This means changing a treaty, and that requires a two-thirds Senate supermajority for ratification—a high hurdle, in our view, given the chamber is presently split equally on party lines.

Meanwhile, some developing countries appear disgruntled at the last-minute exemptions, which they suggest leave the agreement toothless and riddled with loopholes.^[xi] Signatories are supposed to enact legislation next year for the accord to take effect in 2023.^[xii] But we think that may be optimistic given lingering opposition—especially considering matters like America’s 2022 legislative elections.

For investors, even if everyone backs it, tax changes typically don’t have any pre-set market impact, according to our research—and we think the scope of this one is rather minor. It mostly just affects tax havens currently under the minimum, based on our reading of the agreement. But as Estonian Prime Minister Kaja Kallas mentioned when she signed on, it “will not change anything for most Estonian business operators, and it will only concern subsidiaries of large multinational groups.”^[xiii]

Irish economists, too, think changes will likely have only a negligible impact, which history backs up.^[xiv] Ireland raised rates from 10% to 12.5% in 1997 to comply with EU rules.^[xv] Based on our analysis, this did little to curb Ireland’s attractiveness to multinationals over subsequent decades. We think the same is true for the 2017 abolition of the so-called Double Irish tax arrangement, which allowed American multinationals to avoid taxes on their non-US profits.

We don’t think a 2.5 percentage point change in tax rates will affect most big multinationals’ competitiveness much. Besides, the focus on the headline 15% rate seems overstated to us. The agreement’s details could contain more holes than first appears. It remains to be seen how nations interpret the tax incentives and exceptions granted to bring tax havens in line—effective tax rates may be far lower than the proposed global minimum.

Above all, though, taxes are just one small factor for corporations, in our view. We think the economic cycle and business conditions are far larger drivers longer term. We also think the potential for slightly higher taxes, discussed for months now, is likely largely baked into equity markets already. In our view, the issue appears likely to fade into the long-term backdrop, popping up now and then as new developments—or setbacks—occur. Unless there is some big change, we think it is unlikely to have any material effect on markets.