There has been a flurry of debate over Donald Trump’s tax reforms since they were announced in December 2017. Most notably, the corporate tax rate was reduced from 35% to 21%, a massive boon to companies in the US. Following this taking effect on the 1st of January 2018, financial services companies have begun to report on increased profits in Q1 of this year.
JP Morgan & Chase recorded the most substantial quarterly profit by a US bank in Q1, with a net income of $8.7bn. That means that it made nearly $100m in profit every day.
Citigroup posted profits of $4.6bn, a boost of 13% over the previous year. Other institutions, such as Bank of America, Morgan Stanley, or Goldman Sachs, are set to release their Q1 results soon, and the expectation is that the trend of increased profits will continue.
Jobs, Jobs, Jobs
The new tax rate has evidently helped traditional companies in the first fiscal quarter of the year. Increased profits will push up the stock price, in the short term, and companies can use their additional funds to better secure their long-term prospects. Dividends, better investor confidence and the ability to pay down debts will better the position of these institutions.
New jobs and pay raises have followed as well from the tax bill. For example, Apple has promised to create 20,000 more jobs. In late January, as a result of the tax cut Apple, as well as other businesses such as Walmart, AT&T, and Starbucks, announced employees would get bigger pay packets.
Consumer spending drives a larger percentage of GDP, and the new and better-paying jobs will lead to a rise in this. Individuals may also invest their money, either in equities or sovereign bonds, or reduce their own debt exposure. It all looks promising.
Falling Tax Revenues
However, there are lesser-known consequences of Trump’s tax cuts. Government income is going to fall. This has to be balanced by either cutting spending or greater borrowing. The US government is going to have a debt of $21.5trn at the end of 2018, up from $20trn in 2017
These tax cuts are only going to make things worse for the US national debt. A small benefit of increased government borrowing is that it opens up new lines of risk-free investments. Tougher realities need to be faced when it comes to where Washington will cut funding. With some departments already set for spending cuts, like in education, in order to pay for an increased defence budget, there are difficult questions to be asked of policymakers in Congress.
Next up, there is the triangle of employment, inflation, and interest rates. With unemployment set to decrease, the increased spending ability of consumers could lead to inflation in the short run. With increased prices of commodities, interest rates will rise to try and curb possibly dangerous inflation levels. The market slide in Q1 is a prime example of how investor expectations of rising interest rates could affect the stock market.
Increased government yields and interest rates will make it more likely that people will invest their money. This could offset gains in consumer spending from high employment levels. Equities may also prove less desirable, as safer bets will be giving increased rewards. It remains to be seen whether the increase in corporate profits from the corporate tax cut can actually boost the economy, as Trump argued.
Looking back at Reagan’s 1986 tax-cuts, as a basis for comparison, it seems unlikely that there will be a long-term boost. Gross business investment, as a share of GDP, peaked in 1982 began dropping after that. The same could happen for Trump’s tax-cuts, which had the goal of boosting investment into areas such as research and development, or new factories and equipment, helping the economy as a result. But as addressed below, the odds of the extra profits returning back into the economy is not looking good. Companies are looking to pay off debt and repay investors, rather than increasing investment. With no measures to promote investment of the extra profit, history seems likely to repeat itself.
Could interest rates actually go down?
There is another view that interest rates could decrease as a result of tax cuts. If people are more inclined to save their money, or should they invest in bonds because of the extra profit gained from the marginal income tax cuts, there would be an increased demand for financial products such as savings accounts or government bonds. As a result, interest rates and yields on bonds could decrease to counter the increased demand.
What could happen to the economy is fairly uncertain; there is a myriad of factors and causes that could impact the interest rates and how people spend their money as a result of the changes in the corporate and marginal tax rate. Seemingly in the short term, the consequences have not revealed themselves yet.
However, while interest rates could be pushed down slightly, it does not look like this will be the case. The Fed is projected to raise interest rates three times this year. The economy at the end of 2017 was operating at full steam ahead. Trump’s tax-cuts will only serve to over-stimulate the economy, forcing the Fed to speed-up interest rate hikes. An early example of this could be seen in the stock market slide of early March that wiped out much of the 2017 growth.
What corporations actually spend their money on
Unknown to many, corporations armed with more income only spend a small margin of their extra income after the tax cuts on employee benefits or job creation. Apple is reported to repatriate most of the $252bn of cash that it has abroad by making a lump sum tax payment of $38bn to the US government.
Walmart announced that it will spend $700 million to increase salaries and create new jobs, but it is using over $4bn to buy back its stock, which will raise share prices and benefit its investors.
Seemingly, most gains and benefits are being felt by shareholders and executive level employees in receipt of bonuses. This raises the question whether the government could have instead increased spending on areas such as education, as a means to increase future productivity and long-run aggregate supply.
Looking back at the Reagan-era tax cuts, it could be true. The income for the bottom-half of the income pile actually shrunk after the tax cuts, while the richest Americans, the 1%, saw their incomes rise by approximately 6%. The same could happen for the current tax cuts. The potential loss in income for the poorer Americans is largely ignored by the media.
Trends to look out for
With a lower corporate tax rate, there could be an increase in the amount of corporate restructuring. The traditional pass-through entities such as LLPS, Partnerships, and S-corporations could be restructured to C-corporations, which enjoy new benefits for companies looking to reinvest corporate earnings.
There is also the opportunity for businesses to move their operations to the US with the attraction of the lower tax rate that could alter a company’s supply chain management to reduce costs. Overall, the full repercussions of the Trump’s tax bill will reveal themselves as time goes by; they could be the defining factors of the Trump administration. Hopefully, there will not be a decrease in investment similar to that of the post-Reagan tax-cuts.
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