Trump's $5 Trillion Tax Cut Is Coming — What He Wants, and What It Means for Different Kinds of Companies

Trump is copying Reagan again, and this time the cut is bigger than Reagan's famous tax reform.

It is 2021, and President Trump is about to be sworn in for a second term. The 45th president has aged visibly over the past four years. In his few public appearances, he has leaned on his daughter Ivanka Trump for support.

But he is lucky: he has not had to campaign hard to stay in office. He has remained a widely liked president, having pulled off the old trick of expanding the economy with big tax cuts, big spending and big deficits. Under Trump, wages — especially for men without a college degree — have risen sharply, even as climbing inflation has begun to eat into the gains. His supporters praise him for restricting immigration and for the Trump infrastructure program.

That is a fictional future, from a piece The Atlantic published early this year.

In the real one, after Trump's healthcare plan was buried in Congress by a senator from his own party, John McCain, the next big reform waiting to be pushed through is his tax cut plan.

He has been warming it up for a long time, talking about it from the start of the campaign. Just as he borrowed Reagan's slogan, "Make America Great Again," this tax plan keeps getting compared to Reagan's sprawling six-year tax cuts.

Trump himself said during the campaign: "Like most things, President Reagan was right about tax cuts too. His thinking followed directly from President Kennedy's economic ideas. President Kennedy said back in 1962, 'the paradoxical truth is that tax rates are too high today and tax revenues are too low, and the soundest way to raise revenues in the long run is to cut rates now.'"

By Trump's own account, this reform will go further than Reagan's did.

Trump, who governs by Twitter, tweeted on Wednesday: "The approval process for the biggest tax cut in our country's history is about to begin. Move fast, Congress!"

He also wrote: "China's corporate tax is only 15 percent. We have to get down there too if we want to win economically. Jobs and wages!"

Trump may have missed the fact that a Chinese company has to earn a high-tech enterprise certification to get that rate. Most Chinese companies pay 25 percent corporate income tax, on top of a 17 percent value-added tax and employee social insurance and housing fund contributions. China is not a good example to hold up when asking Congress to follow suit.

The details are not public yet, but the framework that is shows what this businessman-president cares about most: corporate tax, and above all the trillions of dollars American corporate giants keep overseas.

A full plan is due on September 25.

Tax Isn't Just Protection Money — It's Also a Way to Steer What Companies Do

Tax pays for the government, and it also steers how a national economy runs. A single increase or cut can change a company's plans.

Between 1960 and 1980, the U.S. economy was stuck in stagflation, with inflation in double digits. The federal government's payroll grew fourfold, and bank interest rates were higher than at any time since World War I.

In 1981 Ronald Reagan introduced the Economic Recovery Tax Act, built around cuts for individuals, lowering the top individual rate from 70 percent to 50 percent. The act did not cut corporate taxes directly, but it exempted a share of companies' investment gains from tax, encouraging investment and cutting taxes at the same time.

The idea comes from an economic hypothesis, the Laffer curve: at a rate of 100 percent, all of a person's income would be taken, nobody would want to work, and revenue would be zero. Only at some optimal rate is actual revenue at its highest.

But in the first year after the reform, the Reagan administration's deficit hit a record $110 billion. The cuts failed to deliver what they promised: lower taxes, a smaller deficit, more investment, a recovering economy. Afraid the deficit would grow further, Reagan passed the Tax Equity and Fiscal Responsibility Act in 1982, followed by a string of other laws, and started raising taxes again.

One economist has estimated that at least half of the tax relief granted in 1981 was later taken back by the government.

By 1986 the economy was recovering, and Reagan went after a second round, this time trying to simplify the tax code across the board, with companies at the center of it. On October 22 that year, he signed the Tax Reform Act on the South Lawn of the White House.

He cut the top corporate income tax rate from 46 percent to 33 percent and reduced the brackets to three. Small and mid-sized companies with low incomes could pay a minimum rate of 15 percent. But from then on, individuals and companies were taxed not only on income but on changes in wealth — buying or selling a house, investing in securities. At bottom, the cuts were meant to spur investment, push people to work harder and more efficiently, and get American companies to build with American money.

Most people count Reagan's reform a success. From November 1982 through July 1990, the American economy grew for 92 straight months, the second-longest run of continuous growth in the country's history.

Trump's Plan Still Fits on One Sheet of A4, and Corporate Tax Is Where the Most Money Sits

The American tax system is extraordinarily complicated. The country has about as many tax preparers per thousand people as a less-developed country like Indonesia has doctors.

Like every president before him who has taken on the tax code, Trump starts by simplifying it. He plans to cut individual income tax from 14 brackets to three: 35 percent, 25 percent and 10 percent.

The biggest sum of money in his unprecedented plan, though, is in the corporate tax code: a flat cut to a single 15 percent rate.

How Much Will Trump's Tax Reform Add to or Subtract From the Deficit? (In Dollars)

$3.7 trillion

Cutting the corporate income tax rate to a flat 15 percent

$1.5 trillion

Individual income tax cuts, three brackets: 10%, 25%, 30%

$1.5 trillion

Raising the deduction — to $6,350 for individuals and $12,700 for married couples

$0.4 trillion

Repealing the alternative minimum tax

$0.2 trillion

Repealing the estate tax

-$2 trillion

Eliminating pre-tax deductions other than for loans and charitable donations

Analysts at Haitong Securities think consumer retail, telecom, raw materials and other industries whose average tax rate is above 25 percent stand to gain the most: lower costs, higher profits.

The technology, internet and pharmaceutical companies listed on Nasdaq paid an average effective rate of about 34 percent last year. They would gain too.

Real estate companies and utilities, on the other hand, have enjoyed sizable breaks in recent years and pay effective rates below 15 percent. They may end up paying more.

Potential Winners and Losers From the Tax Reform

Industry

Current Average Tax Rate and Representative Companies

Consumer staples

30%; Bunge, the American grain company

Consumer discretionary

25.8%; Starbucks, Disney, Marriott, etc.

Telecom

25.2%; AT&T, Verizon, etc.

Raw materials

24.5%; DuPont, ExxonMobil, etc.

Industrials

23.1%; Ford, GM, etc.

Health care

22.3%; Gilead, Pfizer, etc.

Financials

21.5%; JPMorgan Chase, Wells Fargo, etc.

S&P average

21.5%

Technology

17.7%; Microsoft, Alphabet, etc.

Trump's tax reform

15%; companies above this rate pay less, those below pay more

Energy

14.9%; Total, etc.

Real estate

3.9%

Utilities

2.7%

Technology companies earn an average of $28.3 per share; after the reform they would earn another $0.92 per share. Real estate companies would go from making $3.6 a share to losing $0.41.

Barclays, working from the 2016 annual report of Warren Buffett's Berkshire Hathaway, estimates that a 15 percent corporate rate would lift Berkshire's book value by 13 percent, or about $36 billion. At 20 percent, the gain would be $27 billion.

That is the picture for listed companies. For America's small and mid-sized businesses, the reform could cut both ways. Multinationals keep most of their profit overseas and pay tax there, while many small companies make most of their money selling at home, so the reform touches them more directly. But if the incentives are generous enough to pull multinational cash back and fund expansion inside the United States, small and mid-sized companies could end up worse off than ever in competing with the giants.

It is that second outcome — overseas money coming home — that Trump is fighting hardest for.

Like Reagan, Trump Has His Eye on Corporate Cash, Especially at Global Companies Like Apple

Every year, Apple avoids tax by legal means. It has set up subsidiaries in Ireland, Luxembourg, the Netherlands and elsewhere.

That way, revenue from products and services is booked to the overseas units. The money stays abroad and is taxed at local rates — income routed to Ireland, for instance, pays 12.5 percent. Moving it back to the United States would mean 35 percent corporate tax.

Over the past decade or so, as the iPod, iPhone, Mac and a growing App Store business piled up sales, Apple has accumulated more and more cash overseas. Its research and development, meanwhile, sits almost entirely in the United States and runs on American revenue. Apple now holds roughly $260 billion in cash, close to $240 billion of it abroad.

Interviewed by Bloomberg Businessweek in June, Tim Cook said American tax rates are too high and that Apple would consider bringing the money home if they came down.

"The issue isn't taxing international income, it's that the current rate is crazy," Cook said. "Nobody is going to bring money back at 40 percent — I mean 35 percent federal plus state tax. That's the problem." Cook thinks 10 to 20 percent would be reasonable.

Apple's chief financial officer, Peter Oppenheimer, has said much the same: "We continue to generate significant cash offshore, and under current U.S. tax law, repatriating that money to America would result in significant tax consequences."

The arithmetic is simple. On $250 billion held abroad, a 35 percent rate means an $87.5 billion tax bill to bring it home; at 10 percent, $25 billion.

The difference is worth about 62.56 million iPhone X units.

Besides Apple, American multinationals including Microsoft, Alphabet, Johnson & Johnson and General Electric hold roughly $3 trillion in cash overseas.

Trump plans to offer a one-time rate of 10 percent on repatriated cash, and to switch the taxation of multinationals from a worldwide system to a territorial one. American companies' overseas profits would then be taxed only where they are earned, not by the U.S. government — a lure to get big companies to move their money home.

It is not hard to see why he wants it. Last year the United States attracted about $370 billion in foreign direct investment. If just a tenth of multinational cash came back, it would match the investment the country drew in 2013 and 2014 combined.

The Point of Cutting Corporate Tax Is to Get Companies to Invest at Home — and Create Jobs

A 2012 series in The New York Times about Apple looked at what outsourced production by tech companies did to jobs.

Eric Saragoza worked the line at an Apple factory in California in 1995. He and 1,500 co-workers assembled iMacs with the help of robotic arms.

He was soon promoted to an advanced repair-diagnostics team. He and his wife had three children and took out a loan to buy a house with a swimming pool.

A few years into the job, Apple and a wave of other American companies moved manufacturing overseas or outsourced it outright. His supervisor put it this way: building a $1,500 computer in California cost $22 in labor per machine; in Singapore it was $6, in Taiwan $4.85. In the end the work went to a Taiwanese company's factory in mainland China.

Saragoza lost his job in 2002. After retraining, he tried to get back into Apple's California plant. By then it was an AppleCare call center paying $12 an hour. A job that had once been decent, at least in income, ended up as temporary work inspecting refurbished Apple products for $10 an hour.

In 1995, Apple was a computer maker in crisis. Today it is the most valuable company in the world, worth more than $800 billion. But the manufacturing work it creates has all gone abroad. Apple's American employees are either in hard-to-get jobs at headquarters or low-paid Apple Store staff who earn no commission.

Waiting tables, working a shop floor, driving for a ride-hailing app: these service jobs have almost no barrier to entry, no degree or diploma required. It is a job, and that is all. There is essentially nowhere to be promoted to.

American unemployment has hit new lows and the threshold for middle-class status a new high — $59,000 in annual household income — but high-end manufacturing has left the country. The people who used to be middle class lost their jobs, went looking for new ones, and found their old skills no longer fit what the new work required. Their working lives and their private lives changed together.

The people who once held those vanished jobs voted for Trump and helped put him in the White House.

Voting data compiled by Business Insider shows that suburban voters making more than $50,000 a year gave Trump a larger share of their votes. They are not the poorest Americans. They are the propertied class, people who once had, or still have, stable and decent work.

Since winning, Trump has not stopped talking about jobs. This February he asked 24 American manufacturing leaders: "Have you brought jobs back to America?"

"I spoke with Cook, and he promised me he would build three big plants," Trump told The Wall Street Journal in July. In trying to revive American manufacturing, he has made Apple one of the companies he leans on most.

In fact, details from this week's iPhone event show that Apple has built a complete chip business of its own — the CPU, the image signal processor, the earbud chip and more are all designed in-house. Chip development takes heavy investment and can create a lot of jobs. Apple building a chip plant back in the United States is not out of the question.

Trump has also promised tax breaks to companies that build factories in America: everything spent on new plants and equipment could be deducted. That is meant to encourage more investment.

China's Fuyao Glass has already built in the United States; its six North American plants currently pay rates of 35 to 39 percent and would get the lower rate too. Foxconn also plans to invest $30 billion in an American factory.

Besides Tax Cuts, Trump Wants to Use Tariffs to Force Companies to Build in America

The consultancy McKinsey published a report on American manufacturing arguing that the conditions for an industrial recovery are ripe, because "the world's value chains are in flux, and that creates an opportunity for the United States to capture a bigger share of manufacturing."

This February, Trump met at the White House with the chief executives of 24 manufacturers including Ford, Johnson & Johnson and Caterpillar, and asked them, "Have you brought jobs back to America?"

He has also threatened Toyota with heavy taxes to make it change its plans for a plant in Mexico. Such moves cost American jobs, he said, and he meant to end them.

"Move the new plant from Mexico to the United States or face a big border tax" — that was the blunt warning the U.S. president-elect sent on Twitter to Toyota, one of the world's largest carmakers.

Trump wrote that if Toyota insisted on building its new Corolla plant in Mexico while the cars' main future market was the United States, the Japanese company would face an enormous border tax.

Toyota's American subsidiary responded with a statement saying the new Mexican plant would not affect its output or jobs in the United States. Toyota has already built ten factories on American soil.

"Toyota looks forward to collaborating with the Trump administration to serve the best interests of consumers and the automotive industry."

Jim Lentz, chief executive of Toyota North America, said in January that the company planned to invest $10 billion in the United States over five years. The plan, he said, was not a response to Trump's "made in America" talk but part of Toyota's own American growth strategy.

Trump called out General Motors and Ford the same way. They have plants in Mexico too.

Ford went on to scrap a planned $1.6 billion factory in Mexico and expand its production lines in the United States instead.

But this tariff change could hurt American manufacturers themselves, because the plan would not let companies deduct import costs from their profits. Their tax bills would go up, and prices could rise with them.

American toy makers have already built mature production systems overseas, and moving them home just because of a tax change may not be a good idea. Making a toy in the United States costs an average of $10, which would triple the retail price — more, probably, than shoppers would accept.

The Wall Street Journal gave an example. A company imports $1 million worth of toys made abroad, spends $500,000 at home, and sells the lot for $2 million. Before the reform, the taxable amount is $2 million minus $1 million minus $500,000, or $500,000, at a 35 percent rate. After the reform, import costs no longer count as costs, so the taxable amount becomes $2 million minus $500,000, or $1.5 million, at the lower 15 percent rate. Do the arithmetic and the bill after reform is 1.3 times the bill before.

The economist Laura Tyson says robots have replaced 400,000 American manufacturing jobs a year for the past two decades. That is why the manufacturing workforce has shrunk by a third since 1997 even as output keeps breaking records.

So if new tariffs and new costs arrive, executives are quite likely to use them as an excuse to automate faster. Worse, when American companies install industrial robots they tend to buy from Germany and Japan, the two countries that lead the world in advanced industrial robotics.

The Big Reform Leaves Plenty Unsolved, and the Money Coming Home May Not Go Into Manufacturing

The logic of cutting taxes so companies invest more and lift the economy is easy enough to follow. But it is a long way from the idea of tax reform to a change in how companies behave, and longer still to new jobs.

One argument against the plan is that American companies do not, in practice, pay high taxes. Figures compiled by The Wall Street Journal show that federal, state and local tax revenue together comes to about 26 percent of national output. In Germany the figure is 37 percent.

The Government Accountability Office found that two-thirds of active American companies pay no federal tax. And 23 other profitable Fortune 500 companies, GE, Boeing and Verizon among them, paid no federal tax at all between 2008 and 2012. They found enough loopholes to make enormous profits and dodge the tax.

Given that, many economists think business owners do not much care what the rate is.

They also see little evidence that a big cut would make American companies invest more. Lower taxes raise profits, which get paid out as dividends and benefit whoever owns the most stock. Trump has not addressed the chance of that happening, or what he would do about it.

The George W. Bush administration tried a one-time preferential rate for repatriated cash in 2004. To lift employment and growth, it cut the one-time rate to 5.25 percent and required that the money go into investment, jobs and research.

About 30 percent of the overseas money came back. Profits repatriated by multinationals did rise to $300 billion in 2005, 3.66 times the $82 billion brought home in 2004.

But the economy did not visibly improve. GDP grew 2.9 percent in 2005, slower than 2004's 3.6 percent. The stock market, on the other hand, started climbing noticeably from 2005 on: multinationals used the repatriated profits to buy back their own shares and push prices up, which was the opposite of what Bush's tax cut was for.

A recent survey of American executives by Friedman, an international accounting and consulting firm, found that only 23 percent would reinvest repatriated funds. Most would use the money for dividends or buybacks.

What worries Americans more is the deficit.

To balance the budget back then, the Reagan administration scrapped deductions for consumer credit interest, for savings and dividends, and for part of medical spending, broadening the tax base and raising revenue. That brought federal revenue up by more than $100 billion a year, and federal revenue and income tax both rose noticeably as a share of GDP.

Those measures cut the deficit from $210.8 billion in 1986 to $142 billion in 1988. And incomes rose in every economic class, including the poorest, who gained 6 percent.

American debt now exceeds 100 percent of GDP. Cutting taxes and widening the deficit to spur growth may not produce enough benefit to be worth it. So far there is nothing in Trump's outline about balancing the books.

The Nobel laureate Joseph Stiglitz said: "If the Republicans lower rates to an unsustainable level, everyone will believe rates are going to go up. That means you get less investment, because people are thinking about future rates." Trump was the Republican presidential candidate.

In the end the biggest problem is still Trump himself.

Normally an American president sends a draft bill to the relevant congressional committee, and the chair introduces it to Congress right away, either as written or revised. Once the House and Senate vote it through, it goes to the president to sign.

In 1986, it took Reagan 323 days to get his reform through both chambers, after many rounds of negotiating and rewriting its provisions:

• December 3, 1985: submitted to the House
• Debated by the House Ways and Means Committee
• December 17, 1985: passed by the House
• June 24, 1986: passed by the Senate

Trump's plan so far fills a single sheet of A4. And a run of episodes — the ban on laptops on flights to the United States from the Middle East, the decision to deport undocumented immigrants brought to the country as minors, his defense of white supremacists — has already raised doubts of every kind about whether his administration can move a bill at all.

Newsweek wrote: "Part of the reason the 1986 act succeeded is that Treasury Secretary James Baker and Ronald Reagan put forward detailed proposals that helped speed the process along. The Trump administration, however, is mired in chaos and controversy." After a run of personnel upheaval, Vice President Mike Pence is the only member of Trump's core White House team who has not been replaced.

Voter anger may have helped him win the election, but the people he has to win over now are in Congress. He has not even closed the rifts inside his own party. The main reason the effort to repeal Obamacare failed was that his fellow Republicans turned on it.

Some Republican members of Congress told The New York Times that when they describe the president, words like "incompetent" and "unqualified" come out before they can stop them. They worry about his volatile temper.

"We've come to realize this isn't going to change," said a senior Republican aide on Capitol Hill.

Cover image/CNBC