Trump`s tax holiday to make American financial engineering great again: James Saft

The U.S. overseas funds that do find their way home in reaction to any holiday or tax rate reduction will mostly be used to boost financial engineering schemes like share buybacks, rather than funding expanded capacity.

That will be good for U.S. stocks, at least if investors’ Pavlovian response to buy-back announcements persists, but may do little for economic growth, jobs or longer-term corporate prospects.

Trump’s pre-election economic plans included a special one-off tax holiday allowing U.S. firms to repatriate funds held overseas with only a 10 percent payment, versus the current 35 percent rate.

While that could set up substantial repatriation of corporations’ $2.6 trillion held overseas, both history and logic indicate that the lion’s share will be used to flatter per-share earnings by buying back shares rather than to grow top-line revenues.

For one thing, the dollar has risen already and should rise further as expansionary Trump policy stokes inflation and both allows and forces the Federal Reserve to boost interest rates.

“Corporate profits on overseas operations will be reduced, but with demand weak and current profits under downward pressure, the repatriated earnings are likely to go into financial rather than physical investment,” Van Hoisington and Lacy Hunt of Hoisington Investment Management wrote in a note to investors.

Goldman Sachs is projecting that S&P 500 companies will bring back $200 billion of the $1 trillion in cash they hold outside the United States and use $150 billion for share buybacks.

With annual buybacks among S&P 500 firms running at a $592 billion annual clip through the second quarter, that’s a big bump and one the market will greet with enthusiasm.

That’s especially true given that the pace of buybacks has been slowing. Second-quarter buybacks among S&P 500 firms were down 6.8 percent from the same period the previous year. Earnings rose by 3 percent in the third quarter, according to FactSet, the first such rise in six quarters.

On the margins, the repatriation might crimp some bond market issuance, as many firms have borrowed in U.S. markets in order to fund buybacks without having to resort to repatriating cash at prohibitive tax rates.

DIVIDENDS DRIVE RETURNS

We have seen this movie before.

The George W. Bush administration in 2003 passed the Homeland Investment Act, a one-year holiday on repatriations, which “required” that all funds brought back be used for job-creating investments. Plenty of money flew home – $300 million in 2005, the year it took effect. But little of that was actually invested.

A 2010 study by academics at Harvard University, the University of Chicago and the Massachusetts Institute of Technology estimated that for every $1 that came back, there was an increase in shareholder payouts of between 60 and 92 cents. Most of the payout increase was in the form of share buybacks, according to the study- of every $1 repatriated, buybacks increased by 79 cents.

Money is, after all, fungible, and a dollar brought home and “invested” can simply offset planned investment of dollars already here.

blogs.reuters.com/james-saft

(This story corrects paragraph 18 to read “Buybacks are handy…”, instead of “Dividends are handy….”)

(Editing by Dan Grebler)