Should I Stay or Should I Go Now: Ford’s Quest for an Optimal Tax-Efficient Global Supply Chain
How will multinationals with complex global supply chains like Ford adapt to a world with increased political volatility and nationalism?
On Thursday, November 2nd the U.S. House of Representatives released a draft of their latest tax bill titled, the Tax Cuts and Jobs Act. While on the surface the plan seems like a boon for corporations whose tax rate would be cut from 35 percent to 20 percent, the benefits become less clear when we consider an anti-tax-avoidance provision included in the bill that specifically targets multinationals that have shifted operations and profits overseas and store cash in foreign subsidiaries. [1] These proposed changes to the U.S. tax code add to the momentous challenges facing global supply chains, such as, Donald Trump’s criticisms of U.S. trade agreements, including NAFTA and the TPP and the OECD’s Base Erosion Profit Shifting (BEPS) Action Plan released last year, which targets corporate tax avoidance across the 35-nation bloc. [2] With governments around the world increasingly struggling under historic debt loads and political parties with nationalist agendas gaining influence across the globe, what will be the effect of proposed tax measures and future trade policy decisions on the complex global supply chain that is relied on by nearly every multinational?
Tax regimes and trade agreements are integral considerations in the capital budgeting process for companies that have supply chains and operations that span the globe. Firms such as PWC, KPMG and EY provide multinationals with sophisticated consulting services that allow them to consider geographical tax and treaty differences in order to make optimal investment decisions. Any changes to international tax or trade treatment can have massive and persistent ramifications for companies and their earnings. [3] It has been widely reported that Technology and Pharmaceutical companies that tend to be more aggressive in their tax avoidance measures will be massively affected by these changes; however, U.S. automakers with some of the most globally integrated supply chains will face massive disruption as well. Ford in particular is at risk from these changes as they have long-term, capital-intensive projects owned by foreign subsidiaries that supply products to the U.S. Earlier this year we got an early glimpse of how Ford is reacting to political developments when they announced their intentions to move production of their Focus model that had been produced in Michigan to China instead of Mexico. [4] The announcement was a result of a complex analysis of material and labor costs, trade negotiations, tax implications and logistical supply chain risks. The company’s decision to locate the factory in China coincided with Trump’s threats to rewrite NAFTA and punish companies moving jobs overseas.
Over the short term, Ford is continuing to focus its lobbying efforts on Congress and the White House. Ford’s lead lobbyist in Washington, Ziad Ojakli, has been with the firm since 2004 and has close connections with the Republican party. The American Automotive Policy Council that represents U.S. automakers in Washington has also been active since the Trump administration made its original threats to NAFTA and the auto industry. There is some concern, however, that Republicans in Congress who are sympathetic to the industry’s issues feel helpless in influencing the agenda of the White House. [5] Over the medium term, Ford will be reevaluating its location decisions for future plants as shifting political risks are updated and incorporated into the firm’s capital investment models. Depending on the specifics of changes to the tax code and NAFTA, the company may be forced to continue to shift plants out of North and Central America and into Asia.
In addition to its lobbying efforts in the U.S., Ford should begin to reach out to foreign governments that might be made more competitive as a result of the impending policy changes. They should also continue to focus on improving the efficiency of their production process with a specific focus on reducing labor inputs. Labor costs have traditionally been the most significant cost difference when comparing manufacturing in the U.S. relative to other countries and a lower labor cost may reduce the incentives for Ford to move plants overseas. Over the longer term, the firm will need to figure out a way to balance the need to respond to negative political developments while making the capital investments needed to supply its global markets. [6] This will include weighing the incremental benefits of a globally distributed supply chain with the increasingly volatile political climate as it makes decisions that can affect profitability for many years to come.
1. Do the benefits from increased tax revenue to the U.S. Government outweigh the potential harm to U.S. multinationals and their ability to compete in a global marketplace?
2. Are nations becoming obsolete in a world where corporations are becoming more and more globally connected from a both a supply and distribution perspective?
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Sources:
1. Jopson, Barney (2017). US tax reform targets avoidance by multinationals. Financial Times. Retrieved from https://www.ft.com/content/23060b2c-c037-11e7-9836-b25f8adaa111
2. https://www.bloomberg.com/news/articles/2017-11-03/multinationals-may-take-a-hit-from-trio-of-taxes-in-house-bill
3. OECD. Lippert, Tyler H,PhD., J.D. (2017). OECD base erosion & profit shifting: Action item. Northwestern Journal of International Law & Business, 37(3), 541-563. Retrieved from http://search.proquest.com.ezp-prod1.hul.harvard.edu/docview/1945555756?accountid=11311
4. Kiley, David (2017). Forget Mexico: Ford moving Focus production from U.S. to China, with eye on profitability. Forbes. Retrieved from https://www.forbes.com/sites/davidkiley5/2017/06/20/ford-will-move-focus-production-from-michigan-to-china/#2fda1404ef5d
5. Swanson, Ana & Kitroeff, Natalie (2017). ‘Army’ of Lobbyists Hits Capitol Hill to Preserve Nafta. New York Times. Retrieved from https://www.nytimes.com/2017/10/24/us/politics/nafta-lobby-congress.html
6. Balraj, N., & Vetrivel, M. (2016). The impact of international business on the global economy. Splint International Journal of Professionals, 3(9), 50-56. Retrieved from http://search.proquest.com.ezp-prod1.hul.harvard.edu/docview/1906046902?accountid=11311
Thanks for this interesting and timely read, Doug. Your recommendations to secure advantageous trade deals with foreign governments and to reduce labor content in vehicles is spot on. In response to your questions:
1) This is a complicated question, but I believe that the US government would be worse off in the long term by raising taxes on corporations with international supply chains. All else equal, higher taxes on US-based companies would result in lower corporate profits, which would greatly impact shareholders. This would impact Ford and US manufacturers by lowering their free cash flow and their public valuation, which would restrict their ability to invest in the future capital programs, which makes them less competitive in the future. This means lower revenue and less spent on taxes. Alternatively, if firms raises prices in order to sustain corporate profits, they will sell fewer products, which would also lower their revenues and taxes paid. Therefore, in the best case scenario, increasing corporate tax rates will negatively impact tax revenue in the long term. Given that capital is less expensive for the US government than almost any other entity in the world, the government should not be seeking to maximize near term tax revenues at the expense of longer term revenues – they should be the most long-term oriented. Unfortunately, this is where politics and economics do not align – it may be in President Trump’s best interests to raise taxes on corporations with international supply chains to appease those who voted for him.
2) Point taken that national boundaries are becoming less relevant in the world of globalization, but they are still far from irrelevant. Nations pave the way for corporations to be successful by: i) ensuring the populace is amply educated to contribute to the workforce ii) enforcing the rule of law, and most importantly the existence of property rights iii) providing for the basic infrastructure required to operate a business (e.g., roads, utilities, clean water, etc.). Nations differ dramatically in their ability to deliver upon these promises, which is why entrepreneurs flock to the United States to start businesses. Differences also exist on a state by state basis, explaining why so many companies incorporate in Delaware and locate their headquarters in San Francisco. Though people and businesses are becoming increasingly mobile, nations are still highly relevant.
I think that in order to answer question 1, we would have to do a detailed analysis which we are not qualified for. But in general terms, the current situation is not at all acceptable. Companies have been safeguarding profits through tax and financial loopholes, which make the system more complicated than it should be and result in distortions in the firms’ decision-making process. Trying to bring some order to this is not, in itself, a bad thing. I think Andrew’s assessment of the impact assumes that the average effective tax rate will go up as a consequence of this reform, which is something we do not really know. My guess is that, if this plan had the backing of all or most of the Republican party, then the essential backers of the party (who are they, again?) themselves are happy with it. One very likely consequence of this plan is that, regardless of what the average effective tax rate will end up being, the U.S. government will take a bigger share of it, and that is good enough for most parties involved. Also, that additional tax revenue can go back to corporations in the form of subsidies.
I sometimes wonder about question 2 as well. Seems like the tax issue will be solved once we have a very strong global enforcement of tax standards and rates. Also, if we look at history, despite the very-short-term apparent steps back, we see trade globalization becoming more and more relevant. Just from that perspective, a global government sounds like a good idea. However, I do not think citizens of developed economies are willing to let citizens from other parts of the world (which greatly outnumber them) set the universal economic policies. Which is why we do not see citizens from rich democratic countries advocating and acting for stronger democracies in emerging countries. At least for the next couple of decades, it looks like national interests are rock solid. And with them, the States that put them in practice.
I enjoyed the article, Doug. Regarding the first question, I think I would say that the tax avoidance changes are less about trying to increase tax revenue and more about trying to bring an orderly end to the current system of tax avoidance which seems like a drag on the economy. The vast amount of capital that is stuck in overseas markets and unable to be utilized because of the repatriation cost is on balance a net negative. By simplifying the tax code and also making it more easily enforceable, hopefully this money could be brought back and companies could be incentivized to pay taxes in the localities in which they actually operate. I think this is why it is paired with a simultaneous corporate tax decrease.
For question 2 – I think that nations are definitely not obsolete. In fact, they may be more important than before, as we see increasing moves away from global organizations and globalization as countries look inward. I think that multinationals have an important role to play in promoting globalism in a time like we face now where it is increasingly under attack. They can accomplish this through lobbying and attempting to shift public opinion – both are important for their long-term viability to operate in globally-connected markets.
Thanks for a really thoughtful article. In response to question 2- are nations becoming obsolete- I think in the case of a company like Ford, this is far from the case. Ford is truly iconic in its role as a company that embodies American hard work and productivity. For a company like Ford, which has become symbolic of weakened American exceptionalism and specifically, the growing threat of international companies to the American heartland, the concept of nationhood is more important than ever. As a result, a key challenge for Ford will be convincing its employee base and the midwestern community in which it began of the long-term positive effects of global expansion. This is much easier said than done, as the short-term visibility of job loss will almost always trump the argument for future market growth in the eyes of employees. However, a company that has become an embodiment of the American economy cannot easily be disentangled from the public perception of its impact on that economy, and thus on that nation. For Ford, I would argue that nationhood will not be obsolete until the local economy sees the benefits of globalization directly.