Tax-Cut Cash Could End Up in Unexpected Places

Under current proposals, some are expecting Congress to lower the repatriation tax rate to 10%, down from the current rate of more than 30%. It’s unclear whether this would be enough to prod companies to bring the money back because 10% is still more than the average 3.2% rate that big investment-grade companies are paying to borrow money in the bond market.

If corporations do transfer cash back to the U.S., it may not go where lawmakers think it will. To the extent that companies have wanted to build plants or hire more people, they could have already done so. Companies like Apple Inc. and Microsoft Corp. have effectively brought money back home by simply selling dollar-denominated bonds and using the proceeds to execute their grand plans.

What have those grand plans been? Largely buying back shares. This has certainly supported stock valuations, but it hasn’t delivered an obvious boost to Main Street America. More likely, companies like Apple and Microsoft would most likely buy back at least some of the billions of dollars of bonds they’ve issued, reducing debt that was incurred almost entirely to get around the onerous tax rates. This would actually help boost the values of these bonds because it would send money back to investment firms, which would be forced to redeploy it.

Meanwhile, Congress hasn’t outlined a way to pay for these tax cuts, which points to higher budget deficits going forward, which may very well slow growth, not accelerate it. There’s also a belief that tax policies will strip away the advantage companies now have with selling bonds, namely that they can deduct the interest payments from their taxes. This would also prompt companies to buy back outstanding bonds, particularly those with very long maturities, as Bank of America Corp. analysts noted in a report on Tuesday.

As we get closer to actually seeing the holy grail of 2017 for U.S. markets — a comprehensive plan to cut corporate taxes — the market’s response may be substantially different from what many are expecting. The reality is there’s plenty of money in the financial system, including at the big companies that are poised to get a boost. Corporate bond valuations may benefit more than the American economy.