G7 GOVERNMENTS, STIMULUS PACKAGES, AND DEBT
COMBINED DEBT TO GDP RATIO AT AN ALL-TIME HIGH
As shown in Exhibit 1 below, government stimulus across the G7 has led to the combined Debt to GDP Ratio being at an all-time high.
CORPORATE TAXES IN G7 COUNTRIES
Despite headline perception, corporate taxes in G7 countries have been declining over the last 20 years. The notable outlier has been the U.S. which in 2017 significantly reduced corporate taxes from 35% to 21%. Note falling corporate tax rates globally mean that individual taxpayers are carrying the bigger burden in terms of funding government revenues.
Recently, increasing corporate taxes have been recommended by the Boris Johnson (from 19% to 25%) and Joe Biden (from 21% to 28%) administrations. The Biden administration announced a US$2 trillion infrastructure spending plan focused on rebuilding roads, highways, bridges, replacing diesel transit buses and building a national network of 50,000 electric vehicle charging locations. The U.S. infrastructure plan would be funded over 15 years through higher corporate taxes and increasing the global minimum tax for multinational corporations from 11% to 21%.
THE TAX LEAKAGE STRUGGLE
Multinational corporations use tax arbitrage strategies, such as establishing transfer pricing agreements between subsidiaries, depending on where their global operations are based. This problem is not new, but its negative impact has grown significantly. This being due to the increase in size and number of technology companies with subsidiaries that hold their intellectual property in low tax jurisdictions, thereby avoiding the full tax rate at home.
GLOBAL TECH REGULATIONS
Global technology companies such as Google, Facebook, Netflix etc., were already on the radar screen to be subjected to stricter regulations, due to their monopoly-like powers. Not to mention their practice of repackaging media content from traditional providers without cost to the end-user. Since March 2020, these regulatory issues were placed on the back burner as G7 governments focused on containing COVID-19, and providing financial support programs to individuals and corporations to dampen the recessionary impact.
These large technology companies have been the main benefactors of the COVID-19 economy, through higher revenues, earnings, and massive increases in stock prices. It’s only natural that G7 governments turn to them for a higher share of the tax burden going forward, and a few countries, including Canada, are contemplating a new Digital Service Tax.
The Bottom Line
THE IMPLICATIONS OF HIGHER CORPORATE TAXES
What do higher corporate taxes mean for investors? Higher corporate taxes lead to either higher consumer prices or lower corporate earnings in the future. Companies such as Netflix, which have pricing power, will pass along higher taxes to the consumer. Other companies that lack pricing power will try to either increase sales volume or introduce nominal service fees to offset the earnings loss.
Technology companies remain in the hot seat, given their low effective tax rates and monopolistic powers. They will be easy targets for governments looking to generate more tax revenues, with most voters likely supporting the move.
MATCO’S INVESTMENT PHILOSOPHY
As global asset managers, we focus on both macro and company-specific events to better understand how any positive or negative actions impact our portfolio holdings. However, our investment decisions are driven by several of the underlying fundamental characteristics of the company and not just tax impacts. In addition, although we own several technology companies in the U.S. and Canada, our portfolios are well diversified to absorb any ‘shocks’ to one specific sector.
Anil Tahiliani, MBA, CFA
Vice President & Portfolio Manager
Founded in 2006 to manage and service seven family offices, today Matco offers the benefits of our extensive investment management experience to individual investors, foundations, endowments, condominium corporations, trusts, corporations and not-for-profit organizations.
Our mission is to simplify the investment world for our clients by understanding their needs and providing exceptional investment solutions that preserve and grow capital.
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Focus: Canadian Equities