Cutting corporate taxes is a bid to stimulate activity. Companies get a windfall of cash. They can use that cash in a few ways. Firstly, they could pay their workers more money by increasing their wages. Secondly, they could increase investment in new plant and machinery, or research and development. Alternatively, they could return the money to shareholders in the form of higher dividends. The fourth way they can use the cash windfall from a cut in corporation tax is to absorb the money, enabling them to lower prices on their existing product lines. That means lower prices for consumer goods and services. With the new U.S tax legislation, American companies are going to be given an opportunity to do some or all of these actions. Of course, we don’t know exactly what U.S companies will do with their windfall, but there are reasons to believe that lowering prices in a market share “land-grab” will be on their agenda.
Firstly, there is no pressure on corporations to increase workers’ wages. Unions are no longer the force they were and globalization means that foreign cheap labor is a perennial threat hanging over U.S workers. Corporations may spend some of their windfall on research and development. If they do, undoubtedly that is going to be on the better, more efficient use of technology. Returning the cash to shareholders in the form of dividends (or stock buybacks) can be expected in some degree. Certainly, activist shareholders will be lobbying for that if the cash is not used for anything else. This still leaves the option of lowering prices as a big temptation.
Indeed, the “Amazonification” of the globe already appears to be taking hold, where companies’ mindset is to keep prices as low as possible so as to avoid losing market share. We have already seen Amazon gobbling up Whole Foods and putting more downward pressure on consumer prices in the grocery space. Now, look at the proposed acquisition of insurance giant Aetna by CVS Health.
Prescription drug prices in the U.S have been increasing at rates way beyond the overall Consumer Price Index (CPI) over the last four decades. Perhaps the main reason for this is simply corporate greed, bolstered by a lack of adequate legislative control on drug pricing. Manufacturers will charge in accordance with what they think the demand will be – all very laissez-faire in a capitalistic model, but this system has resulted in America having the highest per-capita spending on prescription medicines on the planet. The anticipated deal between CVS Health and Aetna is aimed at improving linkages of data to enable greater synergy. It’s a defensive move by CVS, in the face of expectations that Amazon will be entering the pharmacy business, offering drugs at lower prices. If it goes ahead, the new CVS-Aetna entity will undoubtedly be looking to lower prices for consumers in the years ahead. In fact, as our chart shows, there is already reason to believe that prescription drug prices are at risk of moving into a declining environment, with the year-on-year rate falling sharply throughout 2017.
Prescription drug costs
So there appears to be a desire across the industrial spectrum to keep prices competitive. With that in mind, an unintended consequence of President Trump’s major tax legislation could be that growth in the Consumer Price Index (CPI) remains subdued, and may even fall into negative territory. With the Federal Reserve already perplexed by the lack of CPI growth, this dynamic may confuse them even further.