Special Report: Navigating Biden’s ESG-Driven Tax And Regulatory Agenda

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As business braces for Biden’s 'Made in America' tax and regulatory pressures, here’s what you need to know.
Blenders Eyewear CFO Brian O’Connor

Like all CFOs, Brian O’Connor at Blenders Eyewear, a maker of sunglasses and ski goggles, is reckoning with tougher tax and regulatory regimes ahead. He understands the government has to raise taxes to make up for a Jupiter-sized, pandemic-induced deficit, and is supportive of the Biden administration’s policies on climate change, racial inequality and corporate accountability. O’Connor nonetheless must interpret the impact on Blender’s cash flow, operating expenses and competition.

“The President’s ‘Made in America’ policy to rebuild domestic manufacturing and generate jobs in America makes sense, but for businesses like ours that import crucial goods to make products at lower cost, it can affect our price point,” he said. “And while we support a higher minimum wage, we’re just starting to roll out our retail stores. It’s just a lot to think through.” Eight-year-old Blenders, with $45 million in annual revenue and 35 employees, recently opened its first retail store in Los Angeles.

Thinking through the business dimensions of a new administration’s road map, while always problematic, is complicated by the U-turn made by the current administration. In the space of a few weeks, President Biden has issued an immense and growing number of executive actions, overturning most of the former administration’s policies. For CFOs trying to navigate a profitable journey ahead, Biden’s campaign pledges on ESG—environment, social and governance—objectives is the best place to start.

“The President’s tax, regulatory and trade policies are hinged to generating jobs on American soil and addressing climate change, longstanding racial inequities and business leaders’ governance decisions in these regards,” said Robert Hartwig, a PhD economist and clinical professor of finance at the University of South Carolina’s Moore School of Business. “CFOs must prepare to bear additional regulatory burdens, higher taxes and more financial oversight, but the flip side is more certainty, which is why Corporate America, by and large, was comfortable with a Biden win.”

Taxing Matters

The new administration’s tax policies are a case in point. Higher corporate tax rates and taxes on foreign income are in the cards, but how high is debatable. At present, the corporate tax rate is 21 percent, which Biden pledged during his campaign to lift to 28 percent. He also raised the specter of doubling the Global Intangible Low-Tax Income (GILTI) minimum tax rate on foreign profits of U.S. companies from 10.5 percent to 21 percent.

More likely is something in between, given Biden’s pragmatic nature and reputation for partisan compromise. “Nobody has a crystal ball, but the general consensus is the sweet spot in the corporate tax rate will be in the mid-20s and not 28 percent,” said Jon Traub, managing principal of Deloitte’s tax policy group.

While the GILTI tax increase makes sense as a way to increase U.S.-based manufacturing and jobs, a doubling in the tax rate “might result in competitive ground ceded to foreign companies,” Traub said. “So again, I think we’ll see the rate fall somewhere in between, such as the mid-teens.”

Other possible tax changes floated by the administration include a 10 percent surtax imposed on companies that offshore jobs, another 10 percent surtax on sales to U.S. customers from a U.S. company’s foreign affiliate, and a 12.4 percent increase in the Social Security tax (split equally between employers and employees), among others.

You might be asking what these tax hikes have to do with ESG. The quid pro quo is a range of offsetting tax credits encouraging businesses to invest in clean and renewable energy, buy American made goods and services, and create jobs for people living in disadvantaged communities. An example is a 10 percent “Made in America” tax credit for corporate actions that restore, revitalize or expand business domestically.

“Biden’s tax proposals were not proposed in isolation—they’re designed in the context of his ‘Build Back Better’ economic recovery plan to boost U.S. manufacturing and provide better-paying jobs,” said Marna Ricker, vice chair of tax services at EY Americas. “Taxes are a way to incentivize certain behaviors. Biden sees tax credits as an incentive to invest in clean energy, buy American, and revitalize infrastructure in communities adversely affected by social injustice and racial inequity.”

Boosting Biden’s chances for a compromise tax bill are a healthy stock market, low interest rates, and an economy on an upswing. “GDP is expected to soar 9 percent in third quarter 2021 and 6 to 7 percent in the fourth quarter, compared to 1.5 percent this quarter,” said Hartwig.

Federal Reserve Chairman Jay Powell has indicated that interest rates will remain low for the next couple years and new Treasury Secretary Janet Yellen is on board with this accommodative monetary policy, he noted. “These factors will likely encourage a continuance in debt-oriented capital financing by CFOs, offsetting the tax impact,” Hartwig said.

Epicor CFO Sam Monti

Some companies like Epicor, a global provider of ERP (enterprise resource planning) systems migrating to a cloud-based SaaS (Software-as-a-Service) offering, see higher taxes boosting their business prospects. “Higher corporate taxes will compel our customers like large industrial companies to focus on operational efficiency as a way to drive down their costs,” said Sam Monti, Epicor CFO. “That’s good news for us, since we provide a best-in-class ERP solution designed to do just that.”

While the left wing of the Democratic party will push for tax rates to hew closely to Biden’s campaign promises, Hartwig believes the President’s natural pragmatism and bipartisan reputation will prevail, culminating in a compromise.

“Every president has to contain their left or right flanks, but Biden knows with the slim majorities he has in Congress, a drift too far to the left is a losing proposition,” Hartwig said. “Politically, that’s his biggest threat. But tax hikes are certain.”

Regulatory Rigors

Regulations in the Biden era also are hinged to the President’s ambitious environmental, social and governance (ESH) aims. Hours after he was sworn in, Biden announced the country would rejoin the Paris Climate Accord and cancel the Keystone XL pipeline, dismantling two of the more than 100 environmental actions taken by the Trump administration, with the remainder destined to end up in the same dustbin.

These actions are not unexpected. Biden called climate change the “existential threat of our time.” Nevertheless, he is moving with remarkable speed in gutting Trump-era environmental policies and has stated a goal of making the U.S. carbon neutral, with net-zero emissions, by 2050. For business, these actions are the proverbial shot across the bow—clear warning that environmental harms will not be tolerated. Full and transparent disclosure of quantified carbon footprints must be ready for the asking.

PwC’s Roslyn Brooks

“Almost every section of the government, from the Fed to the National Security Council to the Treasury and State departments, has a special committee now focused on the environment,” said Roslyn G. Brooks, US public policy leader at PwC. “It’s clear that CFOs must be focused on climate change risks and related disclosure requirements, as well as what this means to their strategy, operations and enterprise risk management processes. It’s become that important.”

This importance did not escape the attention of General Motors, whose CEO Mary Barra within days of Biden taking office announced the automaker will end production of all gas-powered cars, trucks and SUVs by 2035, well ahead of the President’s carbon neutral deadline. GM is shifting to making electric vehicles.

Obviously, not all companies are eager to suddenly reposition the business to address what must feel like knee-jerk government climate policies, after four years of the Trump administration’s opposite agenda. Different business groups are seeking more flexible and voluntary government disclosure requirements. The big question is whether or not Biden is open to negotiating a compromise.

If his first days in office are any indication, it appears the President will not pull back on his carbon neutral agenda. This will likely remain the case with his approach to social issues, as well.

“For years, large institutional investors have insisted that companies and boards must oversee their organizations’ environmental and social practices, as they can adversely affect long-term financial performance and shareholder value,” said Brooks. “There is now an administration that is willing to push this forward.”

As Biden pushes, Trump policies fall off the cliff. The prior administration, for example, instituted a Labor Department rule in November 2020, making it tougher for retirement plan sponsors to incorporate ESG funds in their retirement plans. The Biden administration is undoing the rule, as it conflicts with the President’s climate change agenda.

Similar policies are in play with regard to the S in ESG. In his executive order on advancing racial equity and support for underserved communities, Biden make it clear the government’s responsibility is to recognize and redress inequities that serve as barriers to equal opportunity for people of color, members of religious minorities, LGBTQ+ individuals and people with disabilities.

Although many companies have embedded diversity & inclusion initiatives in their management and operating structures and appointed chief diversity officers to oversee these initiatives, the threat of government intervention makes it imperative to follow their lead.

“Government agencies have more clarity around the need to ferret out instances of workplace inequities and punish the offending organizations,” said Hartwig. “A lot of this was happening on its own, but now there is ample reason for every company to pay attention to ESG, given what are sure to be sharper teeth, enforcement-wise.”

Those teeth will bite corporate executives held personally accountable for environmental, health and safety violations, including possible jail time, Biden has said. The President’s choices to head up government agencies also is instructive of his ESG stance. Candidates like Gary Gensler to chair the Securities and Exchange Commission add fuel to the likelihood of more stringent public company disclosures.

If confirmed, Gensler, who earned a reputation for issuing large fines as chairman of the Commodity Futures Trading Commission, can be expected to request additional information on diversity in the workforce and on the board of directors, as well as climate change impacts like greenhouse gas emission metrics. “An SEC led by Chairman Gensler will focus strongly on ESG disclosures, which many investor groups believe is best to protect the interests of investors,” said Brooks.

A Fork in the Road

While Biden’s ESG-driven tax and regulatory agenda is clear, challenges abound. A key impediment is the need to revive moribund government agencies coping with talent departures, damaged bureaucracies, and the loss of morale during the Trump administration.

According to interviews conducted by nine reporters at The Washington Post with staff at multiple government agencies, significant states of “disrepair” are the case at the State, Justice and Agriculture departments; Food and Drug Administration; Environmental Protection Agency; Bureau of Land Management; and the Occupational Health and Safety Administration (OSHA), among others.

Where there is challenge, there is also opportunity. In rebuilding the damaged state of government, Biden will look to restock agencies with people eager to implement his ESG agenda. The onus is on CFOs to prepare for what Ricker calls “a new regulatory calculus… We’re advising CFOs to get a baseline of their current position and then model and plan for what is likely to be ahead,” she added. “A `wait and see’ approach is unadvisable, as the President’s agenda is clear.”

This clarity might make it financially unwise from a tax perspective for a CFO to allocate capital toward building a new plant overseas. From a regulatory standpoint, in light of the administration’s executive order on advancing racial equity risks, it might be imprudent to stick with a board of directors composed entirely of white male members.

The monkey wrench that could strip the gears off Biden’s fast-moving engine of change is the Republican Party, assuming the President forsakes his campaign promise of bipartisan “unity.” His razor-thin majorities in the House of Representatives and the Senate prevailed in pushing forward the $1.9 coronavirus relief legislation, but a more intrusive government agenda could be a deal-breaker.

That said, Biden certainly is seizing the moment. With diehard Trump-supporting Republicans confronting public backlash over the sacking of the U.S. Capitol, the President’s take charge approach is not to be dismissed. “Biden knows he must be extremely aggressive in pushing through his agenda now, realizing that Democrats could find themselves in the minority after the mid-term elections,” said Hartwig.

Time will tell. For now, CFOs like O’Connor are optimistic. The sunglasses and ski goggles maker recently opened its first retail store in Los Angeles and has another one set to open in San Diego in May. “A clear, sound and stable tax and regulatory environment, in general, is good for our business,” O’Connor said. “When customers become anxious, as they have during the past year’s multiple crises, it affects their behaviors in ways that are hard to gauge.”

He added, “2020 was a wild ride we don’t hope to duplicate any time soon. A little stability would be wonderful.”

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