In December 2017, US President Donald Trump signed into law his country’s first major tax reform since the Reagan era. Sometimes new legislation is seismic in its effects, directly altering the playing field on which the citizens of the country operate. At other times, a new law can serve as a useful signpost for greater changes that are already underway. In this case, the tax reform represents a bit of both: It will have important ramifications itself, and it will inform the wider trends that occur over decades. From a geopolitical perspective, the move will have three main effects: It will lead to a repatriation of sizable amounts of cash by US corporations, provide a stimulus for the domestic economy and increase the country’s debt. The combined dynamics of these effects will play a key role in shaping the outlook for the US economy – and its place in the world – for many years to come.
Melting the Cashbergs
Under the previous system, US corporations had incentives to hold their spare cash offshore in tax havens. A high corporate tax rate, coupled with an absence of time limits as to when companies had to repatriate their foreign earnings for taxation purposes, resulted in firms accruing ever larger piles of cash in friendly offshore jurisdictions that were willing to offer favorable terms in exchange for hosting the American giants. The realities of the modern economy greatly impacted this trend. Technology firms whose value largely lies in intangible assets such as intellectual property (iPhone software, for example) found they could choose where they booked their profits because the product was not physical, making its location harder to pinpoint. Accordingly, they often opted to park their profits in tax-efficient locations. The upshot has been the emergence of giant “cashbergs” in offshore havens. One study found that 63 percent of US offshore earnings were reported in six jurisdictions – the Netherlands, Bermuda, Luxembourg, Ireland, Singapore, and Switzerland. The main beneficiaries of this trend have been companies that rely heavily on intellectual property, such as technology firms like Apple, with an offshore stash of an estimated $216 billion, and Microsoft at $109 billion.
The new system implemented after the December 2017 ruling was designed to close these loopholes. US corporations will have to pay tax on foreign earnings as well as domestic revenues, and there are specific new provisions designed to eliminate “profit-shifting” or the retention of profits in more favorable jurisdictions. US companies will thus no longer have the incentive to park their earnings offshore — meaning the cashbergs will likely soon start melting. To sweeten the deal, such firms are only required to pay a reduced tax on these repatriated earnings of between 8 and 15.5 percent (Apple will need to pay a one-off $38 billion bill), making the whole exercise relatively painless for all concerned — except for, naturally, the countries that have been playing host to these vast sums of money. Ultimately, the United States will soon have a tax system in which the financial activity of US companies pads US government revenues, which has not always been the case in the recent past.
US companies will no longer have the incentive to park their earnings offshore, which means that the cashbergs will soon begin melting.
The second effect of the tax reform is the positive boost it will give to the domestic US economy. Officials have cut the corporate tax rate from 35 to 21 percent in a move that has dual benefits. First, the United States will become much more competitive in relation to the outside world, potentially attracting more foreign companies to the country as a base for their operations due to the size of the domestic market of consumers. Second, US companies themselves will immediately witness an improvement in their profit and loss columns as their tax bills decrease. US firms could choose to use this windfall in various ways. The prevailing trend in recent years has been that companies have used any extra funds they have accrued (profits have generally been pretty healthy as of late) to buy back their own shares, driving up stock prices and keeping their shareholders happy. But companies could also put this money to work in other, more productive ways. If US corporations were to see new potential in the US economy or in new technologies, they could invest the money in modernizing their activities or in research and development, which could feed back into potential growth. Indeed, this may already be happening: In January, Apple pledged to invest an extra $30 billion in its US operations as a result of the tax reform.
The End of the Party
So far so good, but as always, every positive comes with a corresponding negative – in this case, it’s in the shape of the debt. By definition, a fiscal stimulus means a short-term reduction in government revenues (or increase in spending), which necessarily results in increased government borrowing. Moreover, the government’s subsequent decision to raise spending on entitlements and defense in the latest budget has increased this effect. The overall result is that the previous targets to balance the budget have now been blown out of the water. Goldman Sachs forecasts a deficit of 5.2 percent of gross domestic product in 2019 and even more thereafter. This will play into the US debt balance: the Congressional Budget Office estimates that the debt-to-GDP ratio is currently around 77 percent, and Goldman Sachs predicts that the figure will rise to 85 percent by 2021 based on the current trajectory. This is high by historical US standards, but compared to some other advanced economies, it remains fairly modest.
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