Show notes
The Inflation Reduction Act includes a variety of provisions regarding tax policy, so how will these policy changes affect corporations and what should investors be aware of? Head of Public Policy Research and Municipal Strategy Michael Zezas and Head of Global Valuation, Accounting, and Tax Todd Castagno discuss.-----Transcript-----Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Head of Public Policy Research and Municipal Strategy. Todd Castagno: And I'm Todd Castagno, Morgan Stanley's Head of Global Valuation, Accounting and Tax Research. Michael Zezas: And on this special episode of Thoughts on the Market we'll focus on what you need to know about some significant changes to tax policy from the Inflation Reduction Act. It's Thursday, August 18th, at noon in New York. Michael Zezas: President Biden has now signed the Inflation Reduction Act, or IRA, into law. As our listeners may remember, last week we discussed the potential impact of the IRA on the U.S. economic outlook. Today we want to dig deeper into a specific area of this new law, namely taxes. So Todd, there's been some criticism of the IRA with regard to the 15% minimum tax on the largest corporations. What are your thoughts on this provision? Todd Castagno: Thanks, Michael. Let's first discuss how this 15% minimum corporate tax operates. So the law now intends for large corporations that earn on average of $1 billion or more over a three year period to pay at least 15%. Now, what's important is what is that profit base to tax that 15% and its derived from financial statement net income with certain adjustments. That is why this tax is commonly referred to as a book tax, that is primarily based on book or financial statement measures of income. So if you peel back a few layers of what's driving the criticism, there's a recognition that this tax effectively just overrides incentives or timing differences that Congress consciously enacted. Critics will say that Congress should just fix certain areas of the tax codes directly. However, the politics of fixing specific policies directly can be extremely difficult politically. The other point of criticism is that taxing authority has effectively been ceded to independent accounting standards setters. Changes in the accounting rules may now affect changes in minimum tax revenue. There have been some concerns from investors over earnings quality as the tail now wags the dog where accounting can now drive the economics. So those are just a few of the criticisms. It's also important to note, Michael, that we've had a version of a book tax back in the 1980s, so it would be interesting to see longevity of this tax as that tax only lasted effectively 2 to 3 years. Michael Zezas: And another piece of the legislation is a softening and reduction of the Corporate Alternative Minimum Tax on advanced manufacturing activities such as automation, computation, software and networking. What can you tell us about that? Todd Castagno: Good question. When Senator Sinema announced a carve out for advanced manufacturing, we were scratching our heads of what that actually meant. Well, it's quite broader and it really affects most manufacturing. So what the adjustment is, is you start with book income and you'd make an adjustment to basically replace what we book for accounting depreciation with tax depreciation. And so tax depreciation is usually front run it and it's usually accelerated versus book. So what that will mean for manufacturers is that their minimum tax base will be lower given this adjustment. Michael Zezas: And also in the IRA is a 1% stock buyback tax for companies that are repurchasing their own shares. Todd, is that likely to impact corporate profits or change behavior in a meaningful way? Todd Castagno: Overall, we don't believe at a 1% level this will materially affect the level of buybacks or corporate behavior. You could see a modest tilt towards dividends as a more preferential form of capital return. You could also see perhaps some buybacks being pulled forward into 22 as the law takes effect in 2023. You know, we think the bigger risk is that 1% rate skews higher in the future if a future Congress needs more revenue. We should also note that it's net of issuances, so that's important. A lot of firms have large amounts of stock based compensation and they repurchase their shares in order to prevent dilution. And so effect of that issuance will also really reduce the amount of the buyback tax. Michael Zezas: And finally, let's talk about tax credits. Which tax credits stand out to you from this bill and how material might their impact be? Todd Castagno: I think this one is in the eye of the beholder. The reality is that the IRA increased credits significantly across the board for clean energy investment, whether that's electric vehicles, decarbonization. Also, the structure of many of those credits has evolved where they can be monetized more upfront, whether that's the refund ability or transferability to other taxpayers. So I think the magnitude of the investment, the magnitude of the credits, outweighs any specific credit or provision. Michael Zezas: Todd, thanks for taking the time to talk. Todd Castagno: Great speaking with you, Michael. Michael Zezas: As a reminder, if you enjoy Thoughts on the market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show.