- Business and lower/middle class to benefit from tax plan, earners in high-tax states to lose
- Tax cuts will power business and personal spending, helping the inflation outlook
- The dollar should keep rising as the likelihood of tax cuts becoming reality looks good
Looking more deeply at the draft House tax bill announced yesterday, the winners and losers from the White House’s tax plans are becoming much clearer. As promised by Trump on the campaign trail, the proposed changes would be a significant win for American corporations and small businesses. The GOP plan is also beneficial for many lower and middle class families, as personal income taxes are set to decrease for many. Losers include those with high incomes in high-tax states, as the bill eliminates many important deductions. The full text of the bill is available here. Our initial take on the bill is that the proposed tax reforms are positive for the US dollar, given the increasing likelihood that they are passed by Congress.
Corporate and small business tax cuts mostly in line with expectations
The House bill cuts corporate income tax from 35% to 20%, while changing the tax regime to a territorial system (from a worldwide system). A recent study found that Fortune 500 companies had $2.6 trillion dollars of profits parked in low-tax jurisdictions such as Ireland. As US corporations are unable to repatriate these holdings without incurring significant taxes, businesses are unable to invest their profits in the US. Foreign competitors face no such burdens, as the US is one of the few countries in the world to impose global taxation. The House bill proposes a one-time tax of 12% on any repatriated funds. The bill also allows corporations to depreciate the entire cost of new equipment in the first year, helping to lower the cost of new investments.
Looking at small businesses, the bill allows small-business owners to pay the first 30% of business profits at a flat 25% personal tax rate. Remaining income will incur the normal graduated personal tax rates.
Personal taxes down for lower and middle class, while rising for high earners in high-tax states
As the bill doubles the standard deduction for singles (from $6,350 to $12,000) and married couples (from $12,700 to $24,000), many lower and middle class earners can expect lower income taxes in the future. The plan also expands the child tax credit from $1,000 to $1,600 for parents.
However, the current bill eliminates the SALT (state & local taxes) deduction entirely, while capping the mortgage interest deduction to $500,000 (from $1,000,000 today). Property tax deductions are also limited to $10,000 per year. Thus the bill is negative for higher income earners in high-tax states such as California, New York and New Jersey.
Implications for the US dollar
Eliminating the current system of worldwide taxation while lowering corporate tax rates have the potential to significantly increase corporate spending in the US. This is especially true given the large amount of funds held overseas by US corporations. Cutting tax rates for lower and middle class earners would also boost consumer spending, as households would enjoy more after-tax cash flow.
Both factors are positive for the US dollar, as increased spending should help the outlook for future inflation. Looking at 5-Year, 5-Year swap rates (a measure of future inflation expectations), expectations for inflation have been rising since the summer, and have jumped significantly this week. This is illustrated below:
Up and away: inflation expectations keep rising
If Trump can jumpstart business and household spending, the key remaining items in his economic agenda include lowering healthcare costs (the US currently leads the world by spending more than 17% of GDP on healthcare) and increasing government spending on infrastructure and the military.
If Trump can get the current tax bill through Congress, expect the US dollar to surge on higher inflation expectations. While initial reactions in the market yesterday were muted following Trump’s failure on the healthcare front, our view is that the likelihood for passing tax reforms is much better. Despite opposition from some House Republicans, particularly given the elimination of the SALT deduction, this didn't stop the previous budget resolution from going through. Echoing the success of the budget resolution vote, both chambers of Congress are once again working closely together. While opposition to the elimination of personal tax deductions such as SALT and property taxes will be fierce, we continue to believe that the bill has a high chance of making it through Congress.