The Taxman May Cometh

Story Highlights:

• President Obama announced on Monday proposals aimed to curb tax benefits received by multinational corporations and wealthy individuals related to offshore profits and accounts.
• The tax proposals touch on a range of popular business practices and aim to shut down tax havens.
• Many of the proposals must be approved by Congress. Despite the imminent Democratic Senate majority, the reception of Obama's tax plans in Congress will likely be colored by popular reception.
• Despite the tax proposals' obvious negative impact on future business, the S&P 500 rose 3.4% Monday. Of late, markets have largely moved higher, ignoring political curveballs.
• The proposals will likely change as they make their way through Congress and won't be effective until 2011. However, tax changes in one country don't necessarily matter much to the whole world, and global investors need to think globally.

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Tax Day may be over, but the taxman's making a second appearance this year. President Obama announced on Monday proposals aimed to curb tax benefits received by multinational corporations and wealthy individuals related to offshore profits and accounts.

Obama's plans—estimated by his administration to generate $210 billion in tax revenue over the next 10 years—will be detailed later this week as part of the White House's formal budget blueprint. The proposals touch on business practices, including deferring taxes on profits earned overseas if the profits are put back into foreign subsidiaries, taking immediate deductions for expenses supporting overseas operations, and taking tax credits to offset taxes paid to foreign governments. The proposals also aim to shut down tax havens by increasing transparency and penalties, including requiring financial institutions to release information about US customers to the Internal Revenue Service.

Many of the proposals must be approved by Congress, and there's little doubt it will be an uphill battle—no one likes the taxman. To that end, about 200 companies and trade associations, including Pfizer, Oracle, Microsoft, Johnson & Johnson, and General Electric, sent the White House a signed letter stating the tax changes would put them at a disadvantage to foreign competitors. Critics warn the extra tax burden may not lead to domestic job creation as the administration hopes, but higher prices and even job losses.

Obama's proposals will likely also find detractors among congressional members, even those in the Democrat rank and file. Al Franken's expected win in Minnesota's contested Senate race will hand Democrats a filibuster-proof Senate majority, but a Democratic majority doesn't necessarily mean a radical, tax-hiking agenda will have free reign. Franken's win and Arlen Specter's defection last week may increase Democrats' ability to advance more extreme legislation, but this doesn't change basic political motivation—i.e., re-election. (Indeed, some speculate re-election was squarely behind Specter's change of heart.) If Democrats are too extreme, they risk a big challenge in around-the-corner mid-term elections. Plus, the Democratic majority means Democrats can no longer scapegoat Republicans for political obstructionism and transgressions—a useful political tool aptly used by both sides. The reception of Obama's tax plans in Congress will likely be colored by public opinion.

Despite the tax proposals' potential negative impact, the S&P 500 rose 3.4% Monday. Of late, markets have largely moved higher, ignoring political curveballs—yawning at Specter's defection and the announcement of US Supreme Court Justice David Souter's retirement last week. Just like Specter's defection won't alter political ulterior motives, Souter's retirement and replacement will unlikely change the court's existing ideological balance.

Increasing taxes may be an unwise move when the economy's weak—both economically and politically. Obama wants to come through on his campaign promises, but if increasing overseas taxes prove hugely unpopular, in the end it won't just be companies that pay—Obama will forfeit some political currency. The proposals will likely change as they make their way through Congress, and they won't be effective until 2011. But remember, as much as most folks detest higher taxes, global investors should think globally—always. Tax changes in one country, no matter how extreme or onerous, don't matter as much to the whole world.