Tax Bill will deliver a corporate earnings gusher
The tax bill that President Donald Trump signed into law last week is going to generate some really strange numbers in the next round of corporate earnings reports. You may have already heard about the negative numbers: Financial institutions and other companies that had near-death experiences during the financial crisis are going to have to take big charges against earnings as the value of their "deferred tax assets" -- past losses that can be used to defray future tax bills -- goes down with the corporate tax rate. That rate is being reduced to 21 percent from 35 percent, which, all else being equal, amounts to about a 40 percent tax cut.
Citigroup Inc., which has by far the biggest pile of deferred U.S. tax assets, at $43 billion, has estimated that it will have to take a $20 billion earnings charge. Fannie Mae and Freddie Mac, which normally hand all their earnings over to the Treasury Department, have cut a deal to retain $3 billion each in order to cover the tax-asset-related losses they expect to face. Other big losers, according to a handy roundup assembled last week by MarketWatch's Francine McKenna, include General Motors Co., American International Group Inc., Bank of America Corp. and Ford Motor Co.
But most big corporations don't have giant piles of deferred tax assets. They're far more likely to have giant piles of deferred tax liabilities -- which means that the new tax law will, along with cutting their taxes going forward, deliver a big one-time boost to 2017 earnings as the lower corporate tax rate shrinks the value of those liabilities. Of the 200 largest U.S. corporations, ranked by market cap, only five have net deferred tax assets of more than $5 billion. Twenty-eight have net deferred tax liabilities bigger than that. The list is heavy on industries that do a lot of capital spending. The US tax code encourages capital investment through the way it treats the depreciation of assets such as power plants and rail infrastructure, allowing companies to record profits that are not taxed until later in the life of these assets. Congress expanded these incentives for business investment in the wake of the financial crisis.
That was in an article about Warren Buffett's Berkshire Hathaway Inc., which seemed to make deferring taxes a top priority in recent years as it bought into the capex-intensive railroad and utility industries. It's impossible to know exactly how these deferred tax assets will convert into earnings gains from the tax bill, in part because some of them concern taxes outside the U.S. Paul Miller, an emeritus accounting professor at the University of Colorado at Colorado Springs who together with frequent collaborator Paul Bahnson of Boise State University alerted me to this strange phenomenon, emailed an abbreviated rundown of the possible impact on Exxon Mobil Corp.'s earnings: As of 9/30, DTL = $34+ billion, and nine months earnings = $11+ billion; project savings from tax cut at 40% x $34 billion, and you get about $14 billion; project 12 months earnings at about $15 billion without tax, and the reported annual earnings jumps to $29 billion for the year, even before the law technically takes effect as of 1/1/18.
That's earnings according to generally accepted accounting principles. As my colleague Matt Levine wrote last spring when people first started discussing the prospect of banks taking big earnings hits from the tax bill: Next time someone complains that companies that report non-GAAP earnings are using "fantasy numbers," let's all remember that GAAP would require Citigroup and Bank of America to report billions of dollars of losses solely because they will pay lower taxes in the future. Under this tax plan, Citi and BofA would have the same amount of money now, and more money in the future, but under U.S. generally accepted accounting principles they would have to report a huge loss anyway. Presumably shareholders would also be interested in the pro forma non-GAAP numbers excluding that loss.
For the companies that have big deferred tax liabilities, GAAP's verdict is less perverse: They'll report higher earnings now, and higher earnings in the future. It's still misleading, though. Financial markets will probably see their way around the distortions when Exxon Mobil, Berkshire Hathaway, AT&T Inc., Comcast Corp. and the like report spectacular 2017 earnings in late January and early February.
But I imagine that headlines like "Tax Bill Delivers $14 Billion Exxon Mobil Windfall" are going to generate a lot of negative public sentiment about the already unpopular tax law. Which is one reason we probably haven't heard the last of those corporate announcements about across-the-board bonus payments to employees. The solution, of course, is to report tax expense = taxes paid or shortly payable and then disclose future benefits or payments without recognizing assets or liabilities.
That's not going to happen anytime soon, though. So brace yourself for a very weird earnings season.