The enactment of the Tax Cuts and Jobs Act (TCJA) on Dec. 22, 2017 dropped the U.S. corporate tax rate from 35 percent to 21 percent, creating the prospect of substantially improved cash flows for many U.S. companies. While the effects of this tax cut are still working their way through the economy, it’s not too early to ask an important question: where did (or will) the money go?
To answer that question, Jeffrey Hoopes, assistant professor of accounting at UNC Kenan-Flagler Business School, joined with Michelle Hanlon from MIT and Joel Slemrod from the University of Michigan to examine the actions and, equally important, statements about actions from public companies following the act’s passage. Using a variety of data sources, they developed descriptive evidence related to which firms made TJCA-inspired announcements, and the extent and nature of what was announced. The goal was, in part, to determine whether the evidence supports a political or economic explanation of the corporate announcements (or both, or neither).
The researchers looked at the under-studied intersection of three variables: the effects of taxes on business decisions, corporate disclosure involving those decisions and business lobbying. As the research paper states, “The first is about reality, the second is what companies say about that reality and the third examines attempts to change that reality.”
Among the key findings:
The study notes that one of the crucial questions debated in the run up to passage of the act was the extent to which it would benefit workers. Using public data on a sample of 163 public companies gathered by Americans for Tax Reform, the researchers found 118 companies announced a one-time worker bonus, 63 stated that they would enact wage increases, 50 indicated they would enhance employee benefits in some fashion and 11 planned additional hiring. Benefits included increases in salaries and minimum wages, one-time bonuses and 401(k) matching. As might be expected, companies that saw their tax rates decrease the most were more likely to announce worker-related benefits due to the act.
There does appear to have been some political motivation in these announcements, in part because these are the companies that had the most to gain from the passage of the act. In total, 4 percent of public firms announced in the first quarter of 2018 that they would pay some portion of their tax savings to workers, according to the research.
In the same time frame, the authors examined conference calls held by the companies that comprise the S&P 500, with 424 companies making the final sample. They found that 95 firms, or 22 percent of the S&P 500, announced during conference calls that they planned to increase investment as a result of the act. On the increasingly controversial question of share buybacks and dividends, the study saw an increase in the first quarter of 2018, but found it to be consistent with the continuation of a long-running trend. In addition, one company, Apple, accounted for a substantial portion of the value. When Apple was removed, the value of the repurchases for the quarter was no higher than that for the first quarter of 2016. Further, while the dollar value was higher, the number of firms repurchasing shares was lower than in 2016.
There were 179 newly announced share repurchase plans in the first quarter of 2018, but only nine of the companies tied their decision to tax reform in the repurchase announcement. “Understanding the motivation of these companies based on their public statements is not always easy, but we concluded that there were generally both political and economic factors at play,” the research paper states.
Though outside the parameters of the original study, the authors have continued to track stock buybacks through the third quarter of 2018. In the second two quarters, they did find a measurable increase in announced buybacks, suggesting more companies were returning capital to shareholders by purchasing their own shares as a result of the act.
In addition to share repurchases and employee benefits and wages, the study used data from the Center for Research in Security Prices to look at the impact of the TCJA on dividends paid to shareholders. Researchers found no evidence that the number of firms announcing either regular or special dividends, or the total amount of those dividends, increased significantly in the first quarter of 2018. There was, however, an increase in the percentage of dividend-paying firms raising their dividends, with 29.8 percent lifting their payouts during the first quarter of 2018 compared to 23.6 percent in the first quarter of 2017.
Hoopes and his colleagues also looked at the number of special dividends, which might have been expected to spike based on the act’s provisions for repatriating capital from overseas. The research found that two of 17 special dividends, two of 18 dividend initiations and 41 of the 344 announced dividend increases were publicly attributed to tax reform. This was not a meaningful increase when compared with historical norms.
The study also sought to explain what types of companies made announcements about TCJA-related employee benefits and investments and why. It examined two primary explanatory variables – economics and politics – and a control that included reasons outside the study such as general economic trends. Political variables included incentives like currying favor with the administration or bolstering the argument for the TCJA and expanding its aims. The economic variables were designed to shed light on the extent to which the TCJA affected corporate decision-making, either by changing the tax-adjusted cost of capital or by providing additional cash flow.
From an economic point of view, the authors point out that companies can distribute cash to shareholders in several ways, including regular dividends, special dividends and share repurchases. Companies that anticipate ongoing cash tax savings as a result of the TCJA may increase their regular dividends. Those that perceive the tax gains to be more transitory may elect to return capital to shareholders using special dividends or share repurchases.
In examining the influence of politics, the authors note that, while research shows the effect of lobbying on policy outcomes remains uncertain, companies are clearly convinced it is worthwhile, as they spend heavily on seeking to influence legislation. In some instances, this is based on the belief that their actions will lead to improved cash flows by affecting future tax policy. The study found that political considerations do appear to have played a role in the decision-making process for many of the companies examined, based on the pattern of announced worker benefits, where companies with PACs that favored GOP-oriented lobbying contributions were more likely to announce a TCJA-linked worker benefit. A high cash effective tax rate was similarly correlated to an announcement of a TCJA-tied worker benefit.
The report states that, while skeptics have tended to view these employee benefit announcements as entirely opportunistic, analysis suggests that the companies most helped by tax reform were the most likely to pass on some of the rewards to their employees. In other words, there’s a logic to the way most companies have reacted to the act.
Looking at dividends and stock buybacks, the authors found some evidence that companies in politically sensitive industries were less likely to increase dividends, and those in highly unionized industries were less likely to announce new share repurchase plans. Companies in red states or that were Republican PAC donors were no more likely to increase dividends or share repurchases than the sample as a whole. Further, there was no evidence that companies with the highest cash ETRs were more likely to increase dividends or announce new share repurchase plans.
The report concludes that announcements about employee benefits, stock buybacks and dividend increases are clearly influenced by both political and economic concerns, but that, in a larger sense, companies have generally responded consistently with the incentives in the act.
“From a purely rational point of view, buybacks and dividends are just another way to provide for the efficient allocation of capital across the economy, whether that money comes from tax reform or through the repatriation of cash held abroad,” said Hoopes. “The investors who receive the capital can determine how it should best be reinvested. But we live in a political world, too, as we can see from the reaction to the announced share repurchases, and companies have to take that into account as well in deciding how best to respond to the impact of tax reform.”
You can access the complete paper here.
Read a recent Triangle Business Journal article featuring this research here.