What Donald could teach Theresa

A massive reform of the US tax code is underway. Britain could learn lessons from our American friends.

Mr Trump’s corporate tax cut clears the Senate

In the wee hours of Saturday 2^nd December the US Senate passed a bill to cut corporate income taxes (taxes on company profits – what the British call corporation tax) from 35 percent to 20 percent. Companies will also be allowed to repatriate their foreign profits at a discounted tax rate. So that could mean that a substantial part of those corporate cash piles held by the likes of Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT) which currently reside offshore will be repatriated to the USA.

The bill was passed by 51 votes to 49. Those senators opposing the bill did so largely on the ground that, by the Senate’s own estimate, it will add an additional $1 trillion to the national debt over the next ten years.


Other provisions in the bill will cut inheritance taxes and dismantle Obamacare with the result – it is claimed – that poorer and less healthy Americans will find it more difficult to get health insurance. The Senate Democrats described the bill as “regressive” – true only to the extent that almost everybody benefits, but the rich will benefit more than the median income family. The bill also goes some way to simplifying the tax system by removing whole classes of deductions. A simpler tax system is one which is more difficult to fiddle.

Republicans claim that this is going to be the biggest change to the US tax system since Ronald Reagan’s reforms in the 1980s. In 1986 the tax on company profits was reduced from 46 percent to 34 percent. Yet that measure swept away so many permissible deductions including investment incentives that corporate taxes actually went up. Mr. Trump’s reform allows businesses to deduct investments from profits in the year they were made up to 2023.

As usual, the devil is in the detail. One such detail – a controversial one – is to disallow the deduction of state and city income taxes for the calculation of profits subject to federal income taxes. This will not be welcomed by companies which operate largely in high tax states such as California and New York. Remember that California has 53 seats in the House of Representatives (39 Democrats and 14 Republicans) out of a total of 435, so that any measure which impacts California gets disproportionate attention. Eleven of the House’s Californian Republicans supported the initial tax bill when it passed through the House in November – but if they were to change sides they could stymie the bill altogether.

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The problem with tax deductions, like with benefits, is that once granted they cannot be abolished without much wailing and gnashing of teeth on the part of those who benefit from them. Critics of the tax bill say that it has been rushed through Congress without adequate scrutiny and that it is therefore likely to have unintended consequences.

Currently the two separate tax bills – one passed by the House at the end of November and one passed by the Senate on 02 December – are being stitched together by a special committee of Congress. This is likely to make significant amendments – for example it was reported last week that the final headline rate for company profit tax may end up at 22 percent. Nonetheless, if the bill is passed into law by Christmas, as President Trump hopes, that will be the first major legislative achievement of his administration.

Who gains?

US corporate profits after tax will rise across the board by as much as 8 percent, according to UBS; but the biggest gainers will be those companies such as banks which do not make large write-downs for capital expenditure. The greatest beneficiaries of this will be shareholders. This could push the US equity markets higher even in the short term: some pundits expect the Dow Jones index to reach 25,000 in 2018.

Also, exporters will be favoured with a special profit tax of just 12.5 percent levied on export income proposed in the Senate bill. During the week of 04 December financial and industrial stocks gained on Wall Street while energy stocks and utilities lagged behind. Interestingly, the big tech stocks – the FAANGs included – stumbled.

And the losers?

According to the Financial Times last Friday (08 December) major foreign-owned international banks operating in the US could be hit because of the way in which they have structured their operations. The problem arises because they may no longer be able to reduce their tax liability by funnelling tax-deductible payments out of the US to other entities in their group. Many foreign banks fund a portion of their US operations with liabilities (e.g. customer deposits) which reside outside of the US. This could negatively impact the likes of BNP Paribas (EPA:BNP), Deutsche Bank (ETR:DBK) and Credit Suisse (NYSE:CS).


Moreover, an influx of US dollars returning to the mother country will, all things being equal, push up the value of the dollar. This in turn will depress the earnings in dollar terms of those US multinationals which generate most of their sales overseas such as Boeing (NYSE:BA), Apple (NASDAQ:AAPL) and McDonald’s (NYSE:MCD).

BEAT is the tax-reform acronym for Base Erosion Anti-Abuse Tax, which is a way for US revenue collectors to reduce the ability of large multinational companies to use cross-border payments to shift income to their affiliates located in lower tax countries. One sector affected by this will be companies that have leveraged investments in US renewable energy such as wind farms. This is not good news for the likes of Vestas Wind Systems (CPH:VWS) which I wrote about in the August edition of Master Investor Magazine.

How the US company tax rate compares

With a company profit tax rate of 20 percent America will still have a higher rate than the UK at 19 percent next year, Germany at 15 percent or Ireland at 12.5 percent, although it will be well below the French baseline level of 33 percent (which President Macron has promised to cut).

But the crude comparison of headline corporate tax rates is misleading because of the differing regimes as to what is tax-deductible. Also, many countries such as France offer differing rates for small and medium sized companies while others like Germany add various municipal taxes to company profit tax.

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Accountants and tax analysts therefore look at the effective company profit tax rate. That is basically the total corporate tax take as percentage of aggregate corporate profits declared. Thanks to generous allowances, the Congressional Budget Office estimates that the effective company profit tax rate in the US in 2012 was 18.6 percent. In contrast, the German effective rate is higher than the headline rate. So the impact of the cut in taxes may not be a great as claimed.

The average rate of company profit tax for the leading industrial nations is 22-23 percent but this has been declining over time. Messrs Corbyn and McDonnell who wish to raise corporation taxes in the UK are bucking the trend. In a global economy, where capital is highly mobile, it is inevitable that corporate profits will tend to be booked in lower tax jurisdictions.

Reform of personal taxes

The House bill proposes to raise the Standard Deduction (that’s the equivalent of our Personal Allowance in the UK) from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for married couples – lower than the current UK level of £11,500. It also proposes to reduce the existing seven tax brackets (10, 15, 25, 28, 33, 35, and 39.6 percent) to just four tax brackets as follows: 12 percent up to $90,000; 25 percent from $90,000 to $260,000; 35 percent from $260,000 to $1,000,000; and 39.6 percent on earnings above $1,000,000.

The bill will eliminate most itemized deductions while retaining the deduction for state and local property taxes up to a limit of $10,000. Deductions for charitable contributions will be retained. (The UK tax code in contrast grosses up charitable contributions to beneficiaries – a highly inefficient system which is easily abused).

Americans will still be able to deduct mortgage interest for existing mortgages on homes of up to $500,000 in value. Mature British readers will recall that MIRAS – by which mortgage interest was made tax-deductible at source (i.e. mortgage payments were subsidised by the state) – was progressively phased out in the 1990s before being finally abolished by Chancellor Brown in 2000.


The median household income in the United States is $56,516, according to 2015 data from the US Census. I calculate that, if the House bill goes through, such a household, assuming one earner, will pay $5,341.92 in income tax – an effective tax rate of 9.45 percent (very slightly up on previous levels). Of course, Americans have to pay State and City taxes as well as property taxes – the latter amounting to around $1,000 per year (less than the average UK Council Tax demand).

Americans also have to pay their own medical insurance and in recent years employers have been pushing the full burden of such insurance onto employees. The average American family spent $9,596 on healthcare in 2012[i] though this figure is likely to be much higher today. Americans must pay for medical insurance plus medical bills up to the threshold where their insurance policy kicks in. If we add the figure for medical expenses to taxes paid by the median American family we get an effective tax plus medical expenses rate of 26.43 percent[ii].

Arguably, American healthcare is generally better than that provided by the National Health Service, certainly in terms of headline outcomes. But most British citizens would argue that there is a material value derived from the peace-of-mind offered by a state-run healthcare service. The difference in outlook is essentially cultural. That said I was struck by a number of Americans I met on my recent trip there who told me that it was about time the USA adopted a state-run health system as in “normal countries”. Of course such anecdotal evidence is not conclusive.

The Death Tax

The Death Tax, or more correctly the Federal Estate Tax, which applies to the transfer of property at death (equivalent to UK Inheritance Tax) on estates worth over $5,490,000, is one that Mr Trump mooted he would abolish during his election campaign.

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Under the House bill, the exemption will be doubled and the tax will be abolished in 2025. Under the Senate bill, the exemption will be doubled but there is no mention of repeal. The final outcome will depend on the ongoing horse-trading. Since only about 0.2 percent of all American estates are subject to Estate Tax, and it is not a significant source of revenue for the Treasury, this measure is largely of ideological value. Imagine what Labour would say if the Tories abolished Inheritance Tax in the UK (as Sir John Major aspired to do).

Economic consequences of the tax cuts

The conventional wisdom is that it is not clever to give a fiscal stimulus to an economy that is already running at full capacity as the economy could “overheat” with resulting inflation. On the other hand, while US employment is low at 4.1 percent, America (like the UK) has a lot of part-time workers who would relish additional hours; and there are a large number of recently retired people who remain eminently employable.

The main objective of the cut in corporate tax rates is to make corporate America more competitive against companies which operate in lower corporate tax rate regimes in Europe and especially Asia. Lower corporate taxes imply higher rates of return (ROC) which in turn should impel higher growth.

What about the deficit?

America is a most fortunate country – as I have written elsewhere. It can run a massive budget deficit as it has done for the last forty years or so and just print the money it needs to cover it without causing inflation. That is because the US Dollar is – for now – the international reserve currency.


Therefore America’s national debt, although huge in absolute and relative terms, is not really a major cause for concern. So long as interest rates remain low – and all the so-called experts think they will for the foreseeable future – the national debt can be relatively easily serviced. Moreover, the demand for US Treasury bills and bonds, domestically and externally, is still insatiable – so the US Treasury need have no fear that it will run out of money.

What do Americans make of the tax bill?

On 11 December the Washington insider newsletter The Hill reported that Republicans are now worried by how the tax reform bill is being perceived by middle-class and lower-income Americans[iii]. According to a CBS News poll conducted last week 53 percent of people nationwide disapprove of the GOP tax bill and only 35 percent approve. Last Friday, Senator Marco Rubio (Republican-Florida) warned that the Republican Party should not allow itself to be identified with big business. While Speaker Paul Ryan (Republican-Wisconsin) expects that a median family of four in his home state would receive an average tax cut of $2,000 from the bill, some lawmakers worry that below-average earners might end up paying more.

Senator Bob Corker (Republican-Tennessee), who was the only Republican to vote against the Senate tax bill, says he’s concerned for another reason: namely that the legislation will erode the GOP’s credibility on fiscal responsibility. Senator Corker has been an outspoken critic of President Trump this year.

The Europeans disapprove

On 11 December the finance ministers from Europe’s five largest economies, including Mr Hammond, submitted an unprecedented joint letter to the White House and the US Treasury Department. The gist of this missive was that the Republican tax reforms contravene WTO rules and could have “a significant distortive effect on international trade”.

Mr Hammond’s decision to sign the letter amounts to a political gamble because it risks angering Mr Trump at a time when Britain is trying to strengthen its trade links with the US in the expectation of a trade deal post-Brexit. It seems certain that Mr Trump will regard the letter as an unwarranted intervention into America’s domestic affairs.

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The Europeans’ major grouse is that foreign-owned corporations in America will be taxed more punitively than American-owned ones. For example, an “excise tax” in the House bill seeks to impose a 20 percent levy on purchases from foreign subsidiaries which would not apply to domestic transactions. The Europeans regard this as discriminatory.

A copy of the letter was sent to Gary Cohn, the top White House economic advisor and to the heads of the congressional committees which are working on merging the House and the Senate bills.

No doubt Mr Hammond thinks that by signing this letter he is currying favour with our European partners. He might have reflected that Mr Trump is actually carrying out his election promises – something which will embolden him to resist European interference.

Key lessons this side of the Pond

The first lesson is that tax reform must equal tax simplification. Streamlined tax codes with fewer loopholes result is less tax evasion.

Secondly, Mr Trump reminds us that, in a market economy, governments are solely responsible for macroeconomics. In practice, macroeconomics is two things – fiscal policy and monetary policy. Monetary policy has been outsourced by the politicians to the priestly caste of central bankers (with deleterious consequences, in my view). That leaves fiscal policy – taxation and expenditure.


As far as possible, people with below median incomes should be taxed minimally or preferably not at all, rather than be accorded special favours by fixing utility prices etc. as the 2017 Tory election manifesto promised to do. The tax paid by the squeezed middle and the just-about-managing in the UK is still far too high and should be reduced to at least American levels.

What governments should not do is to tinker in microeconomics – they should not seek to fix or cap prices, to ration goods artificially or to distort the markets by injudicious regulation. Mr Trump understands that well; Mrs May, apparently, does not.

[i] See: https://www.cnbc.com/2017/06/23/heres-how-much-the-average-american-spends-on-health-care.html

[ii] As ever, my spreadsheet is available.

[iii] See: http://thehill.com/homenews/senate/364054-republicans-fret-over-tax-bills-unpopularity?rnd=1512778117&utm_source=&utm_medium=email&utm_campaign=12556