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Last December the US Congress passed a bill overhauling the tax code, the first major tax reform since 1986. The federal corporate tax rate was permanently slashed from 35%, the highest rate of any large, developed country, to 21%. The tax cut is partly financed by a one-off levy on profits retained overseas by US corporations, at 15.5% on cash and 8% on other investments. Payment of this levy is spread over eight years and applies whether or not cash is repatriated back to the US. The bill also lowered the income tax burden for most American workers.
The tax reforms target the enormous cash piles that US corporates have kept overseas to avoid paying higher US taxes. Ratings agency Moody’s estimates that US non-financial companies hold about $1.4tn in offshore cash and liquid investments, constituting 72% of their total cash holdings at the end of 2017. Much of this is concentrated in the hands of a small number of firms. Under the reforms technology firms are likely to bear significant tax charges, with Apple, Microsoft, Google’s parent Alphabet, Cisco Systems and Oracle being the top five overseas holders of cash.
Supporters of the reform hope that the tax on overseas cash will lead corporates to repatriate huge amounts of money to the US, causing a surge in capital expenditure and job creation. Previous experience point to a more muted response.
In 2004, the Bush administration implemented a one-off tax holiday, allowing corporates to repatriate overseas earnings on which they paid just a 5% tax. A 2011 US Senate study concluded that the policy was ineffective. Corporations brought back $312bn held overseas but there was no corresponding boost in domestic investment or R&D spending. The top 15 beneficiaries of the holiday reduced their total US employment over the next few years. Instead stock repurchases and executive compensation increased. The main beneficiaries were pharmaceutical and technology companies, a relatively narrow section of US multinationals.
This time round it looks likely to be a similar story. When asked in a recent Bank of Merrill Lynch survey about how they would use repatriated cash major US multinationals identified paying down debt, repurchasing shares and undertaking M&A as the top three priorities; increasing capital spending was in fourth place and raising dividends in fifth. Of course some of that increased dividend income will flow to the real economy, but more indirectly, to different sectors and with different effects, than an increase in corporate investment.
A bigger boost to activity seems likely to come more from the reduction in the rate of corporate tax and an immediate write-off against tax for capital expenditure incurred before 2022. Unlike the taxation of overseas cash, which effect a relatively small number of generally large businesses, cutting the rate of corporation tax benefits the whole corporate sector. Some businesses, including Walmart, AT&T and Bank of America have announced wage rises or bonuses in response to the tax cuts.
The new corporate tax rate will put the US well below the weighted average for G7 and G20 countries and could encourage multinationals to increase levels of investment in the US.
The third aspect to the tax reform, which has perhaps received less attention, is the lowering of income tax. A study by the Tax Policy Centre shows that 80% of US taxpayers would receive a tax cut in 2018 – averaging about $2,100. Higher income earners are the biggest beneficiaries, although the study shows that every quintile of wage earners will see a boost to incomes this year with the lowest being a 0.8% raise for those in the bottom quintile.
Assessments of the macroeconomic impact of the tax cuts vary. But the general expectation is for a probably small boost to GDP growth and a sharply increased federal budget deficit. The tax cutting package runs two risks.
Last week’s equity market gyrations felt pretty dramatic. The US market dropped 5%, the worst week in two years. Europe took its cue from the US, with the FTSE100 and German DAX also down almost 5%. The VIX Index, a measure of equity market volatility, also known as the ‘fear gauge’, shot up from what, until recently, have been very low levels.
UK growth has softened since the EU referendum, and at a time when the rest of the global economy is picking up. The pace of UK activity has not closely followed the news flow on Brexit, illustrating how politics is one of many factors influencing growth.
Errors in predicting the future of technology tend to be extreme. At one end are the naysayers, like the Hollywood mogul Darryly Zanuck, who in 1946 predicted that TV would flop, “People will soon get tired of staring at a plywood box every night."
The global economy enters 2018 with good momentum. Expectations for growth this year are rising in many countries, equities are hitting new highs and business confidence is buoyant.
The latest Deloitte survey of UK Chief Financial Officers, released this morning, shows the CFOs enter 2018 more focussed on controlling costs than at any time in the last eight years. CFOs seem to be reacting to slower UK growth and Brexit uncertainties with a renewed focus on costs.
Here is our choice selection of the "and finally" news stories from the Monday Briefing in 2017. Credit goes to my colleagues for tracking down these stories and for forging the right pun or quip. The Monday Briefing is taking a break until Monday 8th January. In the meantime the Deloitte economics team - Ian, Debo, Alex, Rebecca and Tom - wish you a very merry Christmas and a happy New Year.
We are launching our Christmas reading list today. Our ‘top six’ is the product of a lot of reading and some debate in the Economics Team. The list aims to offer a thought-provoking and enjoyable break from the rigours of Christmas. All are available free and online. You can save these articles on your smartphone's or tablet's reading list. To print any use the print icons, where available, on the webpages to ensure the whole article comes out.
Our Christmas Quiz offers an eclectic test of knowledge of economics and business. The answers, and a brief explanation of the factors at work, are at the end of this note.
- Which of the following countries has the most affordable housing market relative to incomes, according to The Economist’s house price affordability index?
It’s official, the UK growth outlook has taken a turn for the worse. By far the biggest news in last week’s budget was the downgrade in the Office of Budget Responsibility’s (OBR) forecast for UK productivity growth over the next four years, from an average of 1.6% to 0.9% a year.
There is no consensus about why UK productivity growth has been so weak in recent years. But with the under-performance running into its sixth year, and other countries struggling with similar problems, the OBR has thrown in the towel and accepted that the days of rapid productivity growth are over.