Tax Reform a Boon for Retailers

Following last year’s poor performance, retailers are bouncing back
January 17, 2018 Updated: January 20, 2018    

WASHINGTON—Consumers are in the mood to spend, thanks to record low unemployment, strong consumer confidence, and a rising stock market. With the recent surge in consumer spending along with tax reform gains, retailers are hopeful for a stellar year ahead.

Americans spent more than expected during the last holiday season. According to the National Retail Federation (NRF), sales during November and December surged 5.5 percent year-over-year, marking the largest increase since 2010.

The results came as a surprise to many, especially given the headlines of the past year about store closures, asset sales, and layoffs.

“That really has been the best holiday season since the Great Recession and more importantly there’s a tremendous momentum heading into calendar 2018 for many retailers,” said Steven Barr, U.S. retail and consumer sector leader at the consultancy PwC.

Retailers pay some of the highest tax rates in the country since they generate most of their income in the United States. Hence the tax law is a big win for many of them.

Manufacturing production increased at a 7 percent rate in the fourth quarter.

“No question, retail is the primary beneficiary of U.S. tax reform,” Barr said. “In fact over the last 12 months, retail went from worst to first.”

Retailers have been paying a 35 percent corporate tax rate, under the old tax code. Combined with an average state and local tax rate of 5 percent, the marginal rate for most them is close to 40 percent. Under the new law, the top corporate tax rate goes down from 35 percent to 21 percent.

“There is a lot of wind at the back,” said Matthew Shay, president and CEO of the National Retail Federation, during an interview with CNBC.

With the tax cuts, retailers will get a big influx of cash, which will give them a room for investment in distribution, marketing, online, and other channels, he said.

In addition, individual tax cuts would put more money into consumers’ pockets. The tax law reduces the individual tax rates and nearly doubles the standard deduction for families. And retailers are confident that they will benefit from this increase in disposable income.

Based on Joint Committee on Taxation estimates, tax reform would generate an extra $100 billion in consumer discretionary income in 2018, Shay said.

In addition, Republicans agreed not to try to implement the controversial border-adjusted tax, which would have had a detrimental impact on a retail sector that sources much of its merchandise overseas. With the border-adjusted tax, companies would not be able to deduct the cost of imports from their taxable income.

“That would have been a $500 billion hit,” Shay told CNBC. So retailers went from potentially losing $500 billion to winning $100 billion, he explained.

“It’s a $600 billion swing that really made a huge difference.”

Winners and Losers

Retail sector bankruptcy risk reached record levels last year. Many traditional retailers have been struggling with weak sales and profits. Department stores like J.C. Penney, Sears, and Macy’s announced thousands of layoffs and hundreds of store closures last year.

In addition, many retailers including the electronics chain RadioShack, apparel chain BCBG Max Azria, and iconic toy retailer Toy R Us filed for bankruptcy protection in 2017.

There’s a level of optimism in the retail industry that I have not felt in over a decade.
— STEVEN BARR Leader, U.S. retail and consumer sector, PwC

Traditional retailers have been hit as consumers increasingly shift to online shopping. The e-commerce giant Amazon.com Inc. has been the biggest winner.

While many traditional retailers struggle, some have managed to differentiate themselves in recent years.

For example, omnichannel retailers that have effectively integrated their in-store and online channels are gaining market share. Traditional brick and mortar company Wal-Mart Stores Inc. is one of them. There are also winners in the department store category.

Retailers with lower price points and fast-fashion chains are also doing well. Off-price retailers such as T.J. Maxx and Ross Stores and fast-fashion brands like Zara and H&M are increasingly attracting middle-class shoppers and are gaining market share.

“The folks that are going to win are the differentiated retailers,” said Barr. And for “undifferentiated” ones, he expects many of them to close more stores and reduce their workforce.

According to him, differentiation has a broad meaning. It can be “value and convenience and can go all the way up to innovation and luxury,” he said.

The rise in spending and tax reform increases optimism for many retailers. Even the ones that are teetering on the edge of bankruptcy can benefit from this positive environment.

“There is going to be stronger cash flow for many retailers, which will help them serve their debts,” Barr said.

“There’s a level of optimism in the retail industry that I have not felt in over a decade.”

“As long as long as we don’t have any significant adverse events from a geopolitical or an economic standpoint we may be on an extended run that could go for many years.”

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