In December 2017, the US Republican Senate slashed the corporate income tax rate from 35% to 21% and the personal tax rate from 39.6% to 37%. In addition, reforms regarding the repatriation of foreign income were also made. This estimated US $1.5 trillion tax cut marks Trump’s first signature legislative achievement during his time in power thus far.
Trumponomics Behind Tax Cuts
With corporate tax cuts seemingly targeted towards the middle class, they have been described as a “jobs bill”. As such, Trump argues that the reduction in tax expenditure will create room for American companies to invest more heavily into human and physical capital. He believes that with greater investment in technology and infrastructure, firms will be able to create jobs and value for everyday Americans, eventually leading to an improvement in their welfare and income. This value can be created a number of different ways, such as through companies reducing the prices of some of its products or through engaging in share buybacks. Whether or not you like Trump and his policies, he makes a decent sales pitch – for now at least!
Repatriation of Foreign Income
Although most headlines focused on the corporate tax rate cut, the implementation of a new territorial tax system involving repatriation of income by US firms on foreign soil, is arguably one of the most crucial parts of this tax reform. Previously, multinationals were effectively taxed twice, as they paid a 35% tax rate on foreign income brought back to the US (Fortune, 2018). As a result, many US companies including Apple and Nike moved over US $2.6 trillion of their profits to offshore tax havens such as Ireland and Bermuda (for Apple and Nike respectively). However, under these new tax laws, US firms are allowed to repatriate cash at a one-time rate of 15.5%, less than the half of the previous 35% tax rate (BCG Report, 2018). The purpose of this legislation is to incentivise multinationals such as American Express, to shell out on one-time tax payments in an effort to unfreeze their previously vaulted up cash in the hope that these firms will give back to the economy. Following the tax reform, Apple announced that it will “radically expand” its share buyback program, increasing their dividend payout and create 20,000 new jobs (Apple Insider, 2017). Additionally, with Wal-Mart stating that it will increase wages by 10% as a result of the tax overhaul, Trump is showcasing that Trumponomics might actually benefit the ordinary American.
M&A Activity
With US companies now having access to increased free cash flows, investors are licking their lips at the prospect of further gains, as companies plan to increase their M&A activity. As the bull market of the last 18 months continues to storm forward in 2018 further fuelling investor optimism, markets have carried on to break more records. With the hottest start in worldwide M&A activity since 2000, this can be attributed to the tax cuts – namely greater funding access and ever increasing market optimism. Thus, in January 2018 alone, this amounted to US $265 billion in announced deals, including the US $17 billion takeover of Thomson Reuters by Blackstone Group and the US $23 billion acquisition of Dr Pepper Snapple Group by Keurig Green Mountain Inc. (Bloomberg, 2018). Furthermore, we can expect to see increased competitiveness in America as firms stray away from spin offs and move towards cross border M&A.
Back to Reality – Debt, Debt and Debt
Unfortunately, you can’t ride this optimistic wave forever. Although this tax reform has a number of positive flow on effects, Trumponomics does have its drawbacks. First key factor to consider is debt. It is quite obvious that these cuts provide a significant short term boost to the economy. However, given that we are in a very evident bull market, is it necessary to further pump up government debt? Are we backing the right side of the short and long term trade off? For all the proponents of Trumponomics and US tax cuts, long term sustainability is a key challenge. With the US already having trillions of dollars of debt, this substantial deficit will be stretched further by the reduction in tax revenues, eventually running the risk of a potential repeat of history – that is the GFC.
Should Australia follow suit?
Following the recent US corporate tax cuts, there has been increased pressure for Australia to follow suit. As a result, there is currently an Australian bill concerning the cutting of corporate tax rates from 30% to 25% over the next 10 years, being debated in the Senate. With an increase in US investment and jobs as a result of the cuts, Australia’s high tax rate environment is potentially detracting many investors. As Australia now claims the unworthy accolade of having the second highest company tax rate in the OECD behind France, there is a big risk that there will be a large decrease in relative global competitiveness, as other developed countries reduce their corporate tax rates. With France planning to cut its tax rate to 25% in the near future, Treasurer Scott Morrison has called for Australian corporate tax cuts as the only way to attract foreign investment into Australia. Furthermore, Business Council of Australia Chief Executive Jennifer Westacotts believes that Australia is “in the midst of a global fight to attract investment dollars” and unless it cuts taxes, it will continue “lagging badly” causing jobs to be lost and wages to decrease.
Whilst the argument for cutting tax rates in Australia is strong, similar to the US, many economists are skeptical on the possible repercussions. The potential effect on Australian citizens, GDP and budget is very difficult to predict –Treasury believes that the increase in foreign investment from the proposed corporate tax cuts would boost GDP by 1.2% over 20 years and the expected increase in employment and welfare would only rise by 0.1%. However, as in the case of the US, with Australia already struggling with a budget deficit of $20 billion, a potential tax cut will come at the detriment of the country’s long term sustainability.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
