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This Bull Market Can Get Even Better. Here's How.

Written By Briton Ryle

Posted June 6, 2014

America has been witnessing one of the longest bull runs in stock market history, with the S&P 500 broader market index extending forward some 190% from its 2009 lows. And yet, despite such relentless appreciation, we aren’t seeing many benefits.

Unemployment is still high, personal wealth is still stagnant, and housing has not quite fully recovered.

One reason might be the lack of reinvestment of corporate profits back into the American economy. The reason for that is too much corporate profit sitting unused in overseas banks; and the reason for that is the high corporate tax rate back home.

Despite its engine revving at high power, America’s economic vehicle is being held back by the high 35% corporate tax rate acting like a locked brake. Release that brake and you’ll really see the economy gain some traction.

Corporate taxation hearings headed by tax law experts including Democratic Senator Ron Wyden scheduled for next month will attempt to find ways of encouraging U.S. corporations to bring their overseas profits back to American shores. But something tells me nothing will really be accomplished until 2017.

The Corporate Tax Shell Game

It is estimated that some $1.95 trillion worth of American corporate profits are sitting idle in overseas banks, growing by about $250 billion a year. Imagine how many factories could be built and how many jobs could be created if that money were brought back home.

Instead, some 360 of America’s Fortune 500 companies, or 72%, have subsidiaries in tax-exempt or low-tax jurisdictions offshore that have been organized for the sole purpose of keeping overseas profits away from American shores — and in some cases even diverting U.S. profits.

“Many large, U.S.-based multinational corporations avoid paying U.S. taxes by using accounting tricks to make profits made in America appear to be generated in offshore tax havens – countries with minimal or no taxes,” explained activist organizations Citizens for Tax Justice and U.S. Public Interest Research Group in their latest report, “Offshore Shell Games.”

The report calculates that some $90 billion a year in corporate taxes are being kept out of Uncle Sam’s reach. As a result, the tax burden is falling onto the shoulders of smaller businesses that cannot afford the intricate game of hiding marbles under offshore shell companies.

“Small businesses are hit especially hard by corporate tax dodging,” Celeste Meiffren-Swango, consumer and taxpayer advocate with Oregon State Public Interest Research Group, declared at a news conference yesterday. “Like all other tax payers, they must pick up the tab for tax dodging by large companies.”

Defenders of tax-harboring stress that a company’s board of directors has a responsibility to protect shareholder interests first and foremost, since that is what it was appointed to do. A corporation’s board is mandated with doing everything legally possible to reduce expenses and increase profits.

If other jurisdictions are charging lower tax rates, the board is obliged to avail itself of the cost saving opportunity — always within the confines of what is legal.

So expressed sportswear maker Nike in response to yesterday’s report:

“Please note that all Nike profits held offshore were earned offshore,” explained company spokesperson Del Hudson in a written statement. “Nike profits earned in the U.S. are fully subject to U.S. tax. The intellectual property related to Nike’s U.S business operations is owned in the U.S. and the profits related to those assets are fully subject to U.S. Tax. Nike’s foreign intellectual property is owned by a Nike subsidiary located in The Netherlands, home of our European headquarters. As our Form 10-K notes, to repatriate offshore assets, Nike would have to liquidate or sell foreign operations and subsidiaries, because much of that is invested in operations (distribution centers, offices, etc).”

If a company conducts business in several foreign markets, it will create subsidiary offices close to each market to facilitate more cost-effective operations. And if this enables a company to save on its tax expense, then investors would demand the board avail itself of that provision.

This explains the increased interest in mergers and acquisitions between American and foreign companies, such as the recent failed attempt by U.S. drug maker Pfizer to acquire the U.K. pharmaceutical company AstraZeneca.

Companies are eager to put their caches of overseas profits to use. But with the high tax rate back home, the most cost-effective way to put that money to work is to buy overseas companies where tax rates are lower and, in some cases, even move the company’s headquarters there.

Bigger Changes Likely

The government faces the same dilemma faced by businesses themselves: how to increase revenue without decreasing your client base. Finding that sweet spot where you gain a largest profit from the largest client base possible is never easy.

“The tax system is kind of a balancing act between collecting enough tax revenue while still allowing U.S. corporations to be competitive in a global economy,” explains Linda Krull, associate professor of accounting at the University of Oregon’s Lundquist College of Business.

Since both sides in this ongoing debate have valid points to make, it is unlikely the conflict will be resolved without some major concessions.

It may not be resolved until the next elections in 2016.

If the pro-business leaning Republicans win the next election, we might expect a dramatic reduction to the corporate tax rate to come into effect in early 2017. To encourage the repatriation of overseas profits more quickly, we might even expect a temporarily ultra-low tax rate as low as 10% for a couple of years.

How can they get such a dramatic cut approved by Congress? All they would need to do is make the case that America needs to speed up its recovery, which is being slowed by the storing of nearly $2 trillion dollars of profits in overseas banks. Lowering the rate brings all that money to America, which companies can use to expand their businesses, build more plants, develop more products, and hire more workers.

When that happens, the U.S. economy will be the beneficiary of a tidal wave of cash pouring in from all over the world, breathing a second wind into the bulls’ nostrils, spurring markets into extending their remarkable run down another impressive stretch.

If you like the run we’re witnessing now, you haven’t seen anything yet. Just wait until all those foreign profits find their way back home. Get ready for part two of what may soon become the longest continuous bull run in American history.

Joseph Cafariello