Originally published by AMP Capital
After much debate and anticipation, the US House of Representatives has passed the Republicans’ tax reform package by a 227 to 203 vote and the Senate has passed it by 51 to 48 votes. It now has to go back to the House for another vote Wednesday morning US time after Senate Democrats insisted on the removal of some minor items to be consistent with a technical budget rule - but this is really just a procedural set back with the House almost certain to pass it again with roughly the same margin. As a result it will almost certainly soon be signed into law by President Trump.
The key elements of the package are well known and summarised in the attachment (albeit the name “Tax Cuts and Jobs Act” will apparently need to be changed as a result of one of the changes forced through by Senate Democrats), but include:
- Lower personal tax rates ranging from 10% up to 37% (although these sunset in ten years - another fiscal cliff? - but too far away to worry about just yet).
- A doubling in the standard deduction (or tax free threshold).
- Caps on deductions for mortgage interest and state and local taxes paid.
- A reduction in the corporate tax rate to 21% from 35% starting in January.
- Repeal of the alternative minimum tax for corporates.
- An instant write off for capital spending.
The tax reform package is likely to provide a solid boost to US GDP growth next year, whereas markets and individuals still appear to be underestimating the size of the boost. Around 40% of Americans seem to think they will see a tax hike as result of the package whereas in reality less than 5% of taxpayers will see a hike and most will see a cut with the bulk of the tax cuts going to households. A typical family at the median income are estimated to receive a $2059 tax cut. So many households will get a positive surprise and this will likely further boost already strong consumer spending next year. The instant write off of new business investment will likely also provide a boost to business investment along with the lower headline corporate tax rate.
In total the stimulus will be around 1% of US GDP in 2018 but the boost to growth will likely be a bit less than this (as tax cuts are always partly saved) at maybe around 0.4% of GDP. At a time when the US economy is already very strong this will likely add to a pick up in US inflation in the year ahead.
Partly reflecting this we see the Fed raising rates four times in 2018 compared to its “dot plot” projection of three and market expectations for just two. This will likely contribute to a rising trend in US bond yields and in the US dollar as the stimulus feeds through.
But what about the impact on the budget deficit? Whatever happened to the Republican focus on getting debt down? The cost of the package is estimated to be around $US1.5 trillion over ten years. While the supply side boost to incentive, growth and hence revenue will provide some offset it will be far short of 100% so there will be some boost to the budget deficit and debt. In the short term this may not be a major problem as it could be offset by the revenue growth associated with a strong economy. But over time it may start to become more apparent as the ageing population continues to impact and when the US economy next slows down. However, it also fits the historic pattern under Presidents Reagan and GW Bush, that sees Republicans’ contribute to a budget and debt blowout when they control the White House and Congress that is then brought under control under Democrat presidents. There is some Republican logic to this in their desire to “starve the beast” of government and so get taxes down when they can making it harder for Democrats to expand the size government when they attain power.
While 2017 has seen a pro-business focus on tax reform and de-regulation (in terms of how regulations are applied) in the US under President Trump, the focus may shift in 2018 a bit. First, it will likely become more difficult to make more progress on pro-business policies that need to go through Congress given the need to attain the support of Democrat senators to get to 60 votes to pass anything through the Senate (tax reform got through with a simple majority as that’s allowed under “budget reconciliation” rules). Infrastructure plans may get up to some extent but beyond that it’s hard to see much more. US politics is also likely to turn more messy into the mid-term elections in November (with the Democrats on track to gain control of the House on current polling) and Trump at risk of adopting a more populist approach to shore up his base (eg with an increasing risk of trade tensions with China after Trump’s “America First” National Security Strategy positioned China as a rival intent on threatening US security and prosperity, intervention in North Korea or tension with Iran).
For Australia, stronger US growth and the flow on globally is positive for export demand and commodity prices and in time this will eventually flow through to stronger Australian growth. But the Australian economy is lagging the US - as evident in labour market underutilisation near 14% compared to 8% in the US - and so the RBA will continue to lag the Fed in raising rates (hiking rates at most just once late next year compared to four hikes from the Fed). So while Australian bond yields will likely rise with US bond yields (albeit more slowly) the declining interest rate differential versus the US will likely depress the Australian dollar over time (or at least keep a lid on it in the face of solid commodity prices). At a policy level, lower corporate tax in the US (and possibly elsewhere) will put pressure on Australia to follow lest Australian companies decide to relocate to the US. However, domestic politics seem to be such that personal tax cuts are more likely to be announced ahead of the next election than seeing the large corporate tax rate start to be reduced.
Please click below to read a summary of the changes