Seemingly Simple Corporate Tax Adds Only 603 Pages to Code

Once upon a time, a certain congressional leader quipped that lawmakers would have to pass a major bill so the public could find out what was in it. The quote, taken widely out of context, took on a life of its own as a supposed avatar for congressional opacity. These days, it seems downright nostalgic compared to Congress’s recent tendency to pass broad brushstrokes of new rules, then outsource the writing to the relevant federal agencies—a potentially yearslong process. It is a nasty habit that prolongs uncertainty, much to businesses’ annoyance. But it also gives markets time to gradually price in change, which can be beneficial even if the rules themselves might, to some, appear suboptimal. For the latest example, let us turn to the 603 pages of rules detailing the corporate alternative minimum tax (CAMT).

This tax, part of 2022’s Inflation Reduction Act (IRA), attempts to close the alleged loopholes that allow companies to report snazzy earnings to shareholders while using an array of deductions and credits to reduce their taxable net income. Now, this seeming divide reflects the simple truth that corporate accounting norms and the IRS’s rules aren’t identical. There is nothing shady or nefarious, and past Congresses seemed to have no problem passing various deductions to placate voters and donors while encouraging investment.

But politicians have lately found it much more convenient to argue big corporations are fleecing the government while catering to shareholders and—in the name of revenue and “fairness” (whatever that means, we don’t deal in eye-of-the-beholder terms like “fairness” here)—decided to clamp down. Hence, the IRA stipulated that from 2023 onward, companies whose annual earnings average $1 billion or higher for three years must pay a minimum tax equivalent to 15% of the income reported on their financial statements.

Congress sold this to the public as a simple way to ensure all companies pay their due. After all, companies already report that number! Multiply it by 0.15, zip, bam, boom, paid. Only, it proved not to be simple at all. Which accounting rules would apply? How would income from foreign subsidiaries factor in? What about mergers and acquisitions? Emergence from bankruptcy? Spin-offs? None of this was clarified when the bill passed, leaving companies to make good-faith estimates of their liability under the new rules in 2023, based on their interpretation. Headaches and compliance costs abounded.

Now, nearly two years after the tax took effect, we have guidelines. A whopping 603 pages of exceedingly technical guidelines that aim to clarify everything and put everyone on a level playing field. But even this isn’t final yet. The rules are now open to the standard public comment process and are subject to further revision, based on industry feedback, before becoming etched in stone. All with an election looming and one or both houses of Congress—not to mention the White House—potentially changing hands in November.

So what is an investor to make of all of this? We suggest not getting hung up on the specifics. Instead, consider the higher view and principles at hand: Companies have been dealing with uncertainty over this tax for more than two years and are now gradually getting clarity. Soon, they won’t have to guess as to whether this tax even applies to them. They will have clear-cut rules. They will get clear guidance on whether they need to amend their 2023 filings. They will have more information to arm them when calculating their 2024 tax bill. As the rules wend their way through the comment process, CFOs and their lieutenants will have time to read up carefully and tease out potential snags for their businesses. They will have time to staff up as needed.

And for markets? Well, the Inflation Reduction Act passed in mid-August 2022. That was during 2022’s shallow bear market, about two months before its October 12 low. While it certainly wasn’t alone, we think it is fair to say that the IRA—and uncertainty over its downstream effects—affected sentiment and therefore contributed to the downturn. Major changes, whatever their intents, can rattle sentiment. Tax overhauls can create winners and losers, and when that happens, markets tend to experience myopic loss aversion as the losers’ gloom outweighs the winners’ relief. This, plus the uncertainty, can weigh for a time. But clearly, markets got over it and got on with it. The S&P 500 is now up 35.3% since the bill passed.^[i]

Then, too, the scope here is small. The Treasury Department estimates only about 100 companies will be subject to the tax, which is really just designed to be a floor (similar to the exceedingly annoying Alternative Minimum Tax for individual earners). Its anticipated revenue is just $250 billion over the next decade total. For comparison, corporate tax revenue in 2023 alone was $421 billion.^[ii] By definition, the tax would apply to a small share of companies’ reported earnings. It is also well-known by now, and if markets are at all efficient, factored into prices.

Yes, we see much to quibble with in the tax itself. It throws the point of deductions into question if they now apply only to some businesses, and it may discourage investments at the margins. But if a tax deduction is the make-or-break factor for a new investment, then it probably isn’t a productive or terribly profitable investment to begin with, making it questionable how much society (and the economy) would really lose from its cancellation. Productive investments with solid long-term returns should still advance.

The larger issue here is that, once again, taxes are proving to be a moving target. It took more than two years to get this guidance, just in time for the rules to potentially change again once the moving vans come and go in Washington, DC. An ever-shifting tax code makes it difficult for businesses to plan. It creates an incentive to hold tight until you know what the rules are before you decide whether to take a risk. Now, the upshot is that the tax code has long been made of shifting sand, and businesses have learned how to deal, profit and grow. But regardless, we suspect the constant flux is more of an investment headwind than the actual tax rules. Stocks would probably benefit from a more permanent system, but we live in the real world, where ideal is a concept and an opinion, not a reality.

Hence, businesses—and markets—don’t let perfect be the enemy of good. They digest changes, get the lay of the land, and keep on truckin’.