Our Global Head of Fixed Income Research and Public Policy
Strategy Michael Zezas reads the fine print of U.S. tax
legislation to understand how it might affect foreign companies
operating in the U.S. and foreign investors holding U.S. debt.
Read more insights from Morgan Stanley.
----- Transcript -----
Welcome to Thoughts on the Market. I’m Michael Zezas, Global Head
of Fixed Income Research and Public Policy Strategy.
Today we're talking about a proposal tucked away in U.S. tax
legislation that could impact investors in meaningful ways:
Section 899.
It’s Wednesday, June 11th, at 12 pm in New York.
So, Section 899 is basically a new rule that's part of a bigger
bill that passed the House. It would give the U.S. Treasury the
power to hit back with taxes on foreign companies if they think
other countries are unfairly taxing U.S. businesses. And this
rule could override existing tax agreements between countries,
even applying to government funds and pension plans.
The immediate concern is whether foreign holdings of U.S. bonds
would be taxed – something that’s not entirely clear in the draft
language. Making the costs of ownership higher would affect
holders of tens of trillions of U.S. securities. That includes
about 25 percent of the U.S. corporate bond market. In short, the
concern is that this would disincentivize ownership of U.S. bonds
by overseas investors, creating extra costs or risk premium –
meaning higher yields.
The good news is that there's a decent chance the Senate will
tweak or clarify Section 899. Consider the evidence that the
motive of those who drafted this provision doesn’t seem to have
been to tax fixed income securities. If it was, you’d expect the
official estimates of how much tax revenue this provision would
generate to be far higher than what was scored by Congress.
Public comments by Senators seem to mirror this, signaling
changes are coming.
But while that might mitigate one acute risk associated with 899,
other risks could linger. If the provision were enacted, it acts
as an extra cost on foreign multinationals investing in building
businesses in the U.S. That means weaker demand for U.S. dollars
overall. So while this is not at the core of our FX strategy
team’s thesis on why the dollar weakens further this year, it
does reinforce the view.
For European equities, our equity strategy team flags that
Section 899 adds a whole new layer of worry on top of the tariff
concerns everyone's been talking about. While people have been
focused on European goods exports to the U.S., Section 899 could
affect a much broader range of European companies doing business
in America. The most vulnerable sectors include Business
Services, Healthcare, Travel & Leisure, Media, and Software –
basically, any European company with significant U.S. business.
The bottom line, even if modified, if section 899 stays in the
bill and is enacted, there’s key ramifications for the U.S.
dollar and European stocks. But pay careful attention in the
coming days. The provision could be jettisoned from the Senate
bill. It's still possible that it's too big of a law change to
comply with the Senate’s budget reconciliation procedure, and so
would get thrown out for reasons of process, rather than
politics. We’ll be tracking it and keep you in the loop.
Thanks for listening. If you enjoy Thoughts on the Market please
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listen.
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