Bankrupt countries are coming after investors

Story originally appeared on Market Watch.

LONDON (MarketWatch) — These are difficult times to be a tax manager at a major multinational. Everywhere you go you are assailed for not paying enough tax.

In the U.K., companies such as Ikea, Starbucks SBUX +0.07%  , Amazon AMZN +0.45%   and Apple AAPL -2.08%   have been under ferocious assault for not paying enough corporation tax. Starbucks faced boycotts of its stores, and actually volunteered to pay more tax. An online petition in the U.K. demanding that Amazon pay more to the government has collected almost 100,000 signatures.


Germany’s Angela Merkel has made tough speeches on tackling corporate tax avoidance. In the U.S., President Barack Obama has been attacking tax-avoidance strategies by corporations. British Prime Minister David Cameron is using his presidency of the G-8 to develop proposals to make companies pay more.

And now the European Parliament is planning to force companies to publish how much tax they pay in each state — it will start with banks but could quickly spread to every multinational doing business in Europe.

Companies everywhere are going to face more and more pressure to pay higher taxes than they do now. There is a problem here for investors. If companies are made to pay more tax, the money is going to come out of the pockets of shareholders — and that means share prices in the most bankrupt nations are under threat.

It is not hard to figure out why nations are going after the corporate sector for more tax revenues.

One reason, of course, is that companies pay less tax than they used to.

When most businesses were domestic and made things in factories, they were relatively easy to tax. The likes of Amazon and Apple are far harder to collect any money from. They can set their servers up anywhere that offers an easy tax break. And they can shuffle their costs and revenues from place to place at the flick of a switch. You can hardly blame them if the big profits end up being made in places where taxes are lowest — very few of us would pay anymore tax than we actually had to.

But the bigger reason is that most developed nations are fundamentally broke.

The degrees of broke-ness varies: from completely and utterly broke, like Greece or Italy; to wobbly, like the U.K., France, the U.S., or Japan; to getting poorer like Germany. But all of them are going to have to raise the percentage of gross domestic product they collect in tax — and many of them very significantly.

The U.S. deficit is more than 7% of GDP. The U.K.’s deficit is just as high. There is very little sign that spending cuts to close gaps of that magnitude are on the cards, nor is there any sign that growth will be sufficiently strong to make up the difference — certainly not in countries like the U.K. or Japan.

Huge sums of additional revenue will have to be raised.

Willie Sutton once famously remarked that he robbed banks because “that’s where the money is.”

In the same way, governments will look to raise more tax from companies because that’s where the money is. It certainly isn’t anywhere else. Ordinary workers are already suffering declining living standards: in most counties wages have not kept pace with rising prices. Sales taxes can’t be raised without tipping the economy into a fresh recession. Payroll taxes can hardly be raised without wiping out scarce jobs.

But right through this recession, company profits have been amazingly buoyant. Take the U.S., for example. Total corporate profits were more than $1.6 trillion in 2012, an all-time record. Likewise, as a percentage of GDP profits are at a record high. Profits for corporations in the S&P 500 index climbed to a record $100.75 a share in 2012, and will exceed $120 a share next year, double the $60.43 seen in 2008, according to data compiled by Bloomberg.

The same is true in most other developed economies. Even in the beleaguered euro zone, while economies contract corporate profits are still rising — one reason why stock markets have been hitting decade-highs.

If governments are to have any chance of closing those deficits they will have to go after corporate profits; there is nowhere else to get the money. There is a big issue here, however, for investors. If companies are made to pay more tax, their profits will fall significantly.

The maths are simple. If a company makes $100 million a year in profit and pays a 25% tax rate it is left with $75 million to re-invest and pay out to shareholders. Push that tax rate up to 35%, and only $65 million is left. It is unlikely the company can pass higher taxes onto consumers, or to suppliers. It is shareholders that will take the hit — and the money will come straight out of profits.

True, it may prove impossible to tax the corporate sector more. Corporations have become mobile. Digital files can be sold from anywhere. There will always be a tax haven somewhere that will slash rates to attract a wave of investment. And yet if the major economies work together, they may well succeed. Multinational companies have to sell things where their customers are, and as Starbucks has found in the U.K., if a country is determined to make you pay more tax there is probably little choice but to dig into your wallet.

There is a warning in that for investors.

In the medium term, companies operating in the countries with huge deficits will suffer. In practice that means the U.S., U.K. and Japan are the most vulnerable — their companies will end up paying more. So are most of the major euro-zone corporates.

But companies based in low-deficit nations such as Switzerland, Scandinavia, and of course the emerging markets, will do much better. There will not be anything like the same pressure on their companies to pay more tax — and those markets will outperform their bankrupt rivals.