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Analysis

Trump's muted tax cut

Market movements vindicate OMFIF prediction

by Ben Robinson in London

Wed 6 Dec 2017

In OMFIF's January 2017 report, 'Trump – The search for an improbable balance', on the US economy under Donald Trump, we focused on the possible impact of the president's tax proposals. The report highlighted that many companies, particularly large tech firms, already pay less than half the statutory corporate tax rate of 35% as a result of loopholes, deductions, and profits being booked offshore.

We predicted that Trump's tax proposals would 'create a divergence between domestically operating firms which lack the option of booking profits offshore and pay close to the statutory rate, and multinationals which take advantage of lower rates… The outsized impact of a corporate tax cut on domestic companies rather than multinationals helps to explain why domestically-focused US stock indices have strengthened more than the internationally-focused S&P 500 on news of Trump's fiscal plan.'

We anticipated that 'cutting the corporate tax rate is unlikely to have a stimulatory effect for those large companies already paying below the statutory rate, and may instead lead to loss of revenue from domestic firms, lowering the already weak contribution of corporate taxes to federal income.' Indeed, corporate tax revenue fell to 1.6% of GDP in 2016 from 5.9% in 1952, contributing just 9% of government revenue last year. The effect on US debt could therefore be substantial, with extensive implications for monetary policy under Jerome Powell, the incoming chair of the Federal Reserve.

In vindication of these forecasts, the S&P 500 fell on the first trading day after Trump's tax plan passed a key vote in the Senate on 2 December, closing 0.1% down. Falling share prices for the largest technology companies, including Google, Amazon and Microsoft, contributed to the drop. These movements reflect the pressures highlighted in OMFIF's report.

The reality for growth might be worse than was anticipated at the start of 2017, as other elements of Trump's proposed fiscal boost, including a large infrastructure spending programme, have not materialised. While the Russell 2000 and other domestic indices were bolstered by Trump's election, in anticipation of the improved growth prospects for domestic companies, those hopes have receded. The Russell 2000 fell around 0.3% on the first trading day after the vote.

It is becoming increasingly clear that Trump's plan will not be as stimulatory as his supporters claim. Added strain on US debt and the deficit will further complicate policy-makers' already difficult task. With monetary policy tightening, labour markets near full capacity and the post-crisis recovery entering the later stages of the business cycle, the effect of Trump's tax cuts will be muted.

Ben Robinson is Senior Economist at OMFIF.

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