tax reform The Trump Risk

Donald Trump's Republicans are getting serious about reforms that could impose a border tax to offset cuts to domestic corporate levies. That could seriously hurt German businesses, especially pharmaceuticals and carmakers. Financial investors beware.
It may look peaceful, but inside lawmakers are plotting a move that will draw the ire of foreign firms.

Stock markets around the world celebrated Donald Trump's election back in November. Investors were thrilled by his plans to cut taxes and invest in infrastructure back home. Foreign investors in particular ignored the risks, many of which are only just becoming clear.

Mr. Trump's plans, particularly on taxes, are now getting concrete. A plan for tax reform by Republican Party lawmakers could lower the corporate tax rate from 35 percent to 20 percent and move to a territorial tax system. For the plan to be revenue neutral – and to follow through on Mr. Trump's campaign promises – lawmakers are talking of a border-adjustment tax. That could amount to a 20-percent import levy on goods from abroad.

If passed, these measures would be especially dangerous for an exporting nation like Germany – disastrous for some of its key industrial sectors. German manufacturers generate an average of 10.5 percent of their sales through exports to the United States, according to calculations by Feri, an investment company. Companies have exported goods and services worth €108 billion, or $115 billion, to the United States in the last 12 months alone.

But the effects wouldn't just stay with Germany. Higher taxes could have a knock-on effect on the price of goods made by German companies and sold abroad.

While many US politicians defend the reforms, critics especially in Europe argue that it would make the US an exception in global corporate taxation.

"The tax-related increase in the cost of German exports reduces either the sales potential on the local market or the profits of companies, unless higher prices can be achieved," said Feri CEO Axel Angermann.

Financial investors in German companies should beware. Such protectionist measures will probably be reflected in the share price of affected firms. Feri said that the pharmaceutical industry would be particularly hard hit, given that US exports make up 37 percent of the sector's sales. The United States is also a very important market for makers of data processing equipment and for vehicles, especially aircraft, accounting for 22 percent of total sales in those industries.

Mr. Angermann sketched out some possible consequences, taking aircraft makers Airbus and Boeing as an example. "Airbus would see a significant deterioration in its competitive position compared to its US rival." He said both companies produce products mainly in their home region but sell them worldwide. Airbus states this clearly in its balance sheet: "Airbus generates the bulk of its sales in dollars, while a significant portion of the costs are incurred in euros."

The major pharma companies have not commented on the issue. The Merck Group, which makes more than a quarter of its sales in North America, employs as many people in the United States as in Germany, according to Chief Executive Stefan Oschmann. It isn't clear yet how the tax reform plans could impact his company, he said at an annual press conference, adding that Merck must wait and see what exactly the United States is planning. Rival Fresenius generates half of its sales in North America, while its FMC subsidiary generates more than 70 percent there. However, the group also has large production sites in the US, and many products cannot simply be replaced by others.

While many US politicians defend the reforms, critics especially in Europe argue that it would make the US an exception in global corporate taxation. Economists have argued that a border tax could also trigger protectionist defensive reflexes among other countries and hamper open global markets. This in turn could hurt the United States: San Francisco Federal Reserve President John Williams in an interview this week warned that interconnected supply chains made trade barriers "one of the bigger risks" to the US and global economy today.

This prospect has the pharma industry worried. "If such an important trading partner as the United States were to isolate itself, it would have a negative impact," said Norbert Gerbsch, deputy managing director of the Federal Association of the Pharmaceutical Industry. Both imports and exports would probably be seriously affected by a US border tax. According to figures from the German Federal Statistical Office, pharmaceutical products worth €13 billion went to the United States in 2015, while imports amounted to €7 billion.

The interruption to supply chains is also a widespread concern: "In global trade, many products are made up of elements from many different countries," Mr. Gerbsch said. The tax allocation of active substances, adjuvants, packaging materials and finished medicinal products at all the different stages of production would become complicated.

Other sectors face similar problems, such as semiconductor maker Infineon. The company, with the US accounting for more than 10 percent of total sales, supplies customers in the United States with chips made in Europe and packaged in Malaysia. At the same time, however, the company runs a small factory for high-quality chips in Silicon Valley.

Other industries are watching Mr. Trump's statements closely. Auto managers have been fearful ever since he publicly took aim at Germany's carmakers. Yet while US exports only account for about 10 percent of revenues in the auto industry, machine engineering supply chains are more exposed.

"In light of the planned immediate depreciation of assets, the border adjustment tax being considered would probably not be directly relevant for German exporters of complete machines," said LBBW analyst Stefan Maichl. But the situation would likely differ for machine components, and companies might move to make a larger share of products in the US, he said.

Overall, the proposals could affect small and mid-sized companies more than larger companies which can react more flexibly, no matter what industry they are in, Feri's Mr. Angermann said.

For now, the companies are still hoping the US government will reach a sensible decision. "Growth and prosperity can only be achieved globally by eliminating trade barriers," said lobbyist Mr. Gerbsch.

It is unclear whether Mr. Trump will succeed with his tax plans, and he can ill afford another defeat like he did on health-care reform last month. But James Athey, an investment manager at Aberdeen Asset Management, said implementing the tax reform plans would be easier than getting rid of Obamacare. "The tax reforms are much more popular and will likely gain the support of some Democrats," he said.


Handelsblatt's Maike Telgheder covers the pharmaceutical sector, Susanne Schier leads Handelsblatt's private investment team. Joachim Hofer contributed to this article. To contact the authors: [email protected], [email protected]