Tuesday, December 18, 2018
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US President Donald Trump’s Tax plan unveiled

Donald Trump tax plan | Econ Alerts

Trump tax plan likely to be dollar positive but hurdles remain before passage

 

As reform of the US tax code – a key campaign pledge of President Trump – gets closer to completing its passage in Congress, a possible clash between the Senate and the House threatens to derail it. The stakes are high as Congress’ approval of the tax reforms would represent the first legislative victory for President Trump since taking office. Market reaction has so far been muted as investors await the final version of the bill to assess how expansionary it would be on the US economy.

The House Republicans will be meeting this week to revise the Trump administration’s tax plans announced last week as aspects of the bill is facing significant opposition by some Republicans. The bill also falls short of the Senate’s budget rules, suggesting that President Trump’s hopes for the passage of the tax reform legislation by Christmas may be too optimistic.

It is expected that the House Ways and Means Committee, which is responsible for scrutinising all bills relating to taxation, will complete its review on Thursday, with a vote on the revised bill planned before the Thanksgiving holiday on November 23.

While financial markets have broadly welcomed the much-anticipated tax reforms, it has drawn a lot of criticism from both Republicans and Democrats alike. Key issues for lawmakers are the elimination of many tax breaks such as the state and local tax deduction (SALT), the student-loan-interest deduction and the home-mortgage-interest deduction.

Changes to the home-mortgage-interest deduction have already led to a sharp sell-off in shares of homebuilders on fears that the lowering of the threshold on loans from $1 million to $500,000 would make it too expensive for middle-class Americans to buy a house.

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There are also concerns that the tax plan favours the rich even though the Republicans have been touting the reforms as beneficial for the middle-class. Plans to eliminate the estate tax (which only applies to estates worth more than $5.6 million) and the alternative minimum tax, as well as the lifting of the top income tax bracket of 39.6% to earnings above $1 million for married couples have not gone down too well either by the critics.

However, the tax bill proposes massive tax cuts for both businesses and individuals. The highlight is the cut in the corporate tax rate from the current 35% to 20%. Despite rumours that the cut would be phased in, Republicans are pushing for the reduction to come into effect in one go. Such a big cut is sure to further energize shares on Wall Street if approved. Major US indices such as the Dow Jones, the S&P 500 and the Nasdaq have been setting record highs all year and a large cut in corporations’ tax bill would boost earnings, extending this year’s impressive rally into 2018.

Changes to the income tax brackets also promise major tax deductions for individuals. In addition, families stand to gain from an increase in the size of the child tax credit, while other reliefs include a new 25% rate for pass-through businesses, which would benefit individuals who own their own business.

The size of the tax reductions is estimated to amount to $1.41 trillion and is likely to have a notable impact on growth as the cuts could fuel personal and corporate spending. Higher growth has the potential to inflate price and wage pressures at a time when the US economy is already near full employment. Higher inflation would, in turn, prompt the Fed to raise rates at a faster pace than they otherwise would have without the tax cuts.

A shift in the Fed’s rate hike path from the current gradual to a more aggressive one could be the trigger the dollar needs to resume its Trumpflation rally after almost a year of consolidating.

Apart from the direct fiscal stimulus boost, the greenback also stands to gain from another key tax policy – the repatriation tax. If approved, the new repatriation rate of 12% would be a one-time but mandatory tax on the overseas assets of US companies. Such a measure could temporary boost dollar demand as companies ‘repatriate’ their overseas cash earnings to the US.

Also worrying for financial markets would be the potential impact of the tax reforms on the bond market. It is estimated that the tax reforms will add $1.49 trillion to the US deficit over the next 10 years. If the tax bill passes in its current form and Congress does not find ways to trim spending elsewhere, the massive increase to the national debt could pressure Treasury Notes, leading to a steeper yield curve and this would be positive for the dollar.

But a more immediate concern about the cost of the tax plan is whether it breaches Senate rules. The budget resolution for the fiscal year 2018 approved by the Senate earlier in October allows the national debt to rise by no more than $1.5 trillion over the next 10 years. Although the cost of the tax bill falls just under that limit, some argue that unless the reforms succeed in generating more revenue, the Republicans would need to find ways to reduce a projected shortfall if they want to avoid some of the cuts being reversed after 10 years.

Republicans are now aiming for the House Ways and Means Committee to complete its review of the tax plan by Thursday and for the House to vote on the revised bill before the Thanksgiving break. In the meantime, the Senate is working on its own version of the plan. The Senate’s version will likely be unveiled at the end of next week with a vote expected in early December after the two versions have been reconciled.

Should a final bill manage to make its way to President Trump’s desk before the end of the year, it would signal the first big legislative win for Trump and his Republican party since coming into power. The failed attempts at repealing and replacing Obamacare had dented investors’ confidence in the Trump administration’s ability to see through a major tax reform program, contributing to the dollar’s decline earlier in the year.

The risk of a defeat of the bill in either the Senate or the House shouldn’t be underestimated as the plan doesn’t appear to have impressed voters, with many Americans not convinced that they will benefit from the tax cuts. This could sway Republican lawmakers in Democratic-leaning states to vote against the plan. However, If the tax legislation is able to overcome opposition in Congress, the successful passage of the bill could provide markets with an early Christmas present, lifting equities to fresh record highs and bringing the 116 yen level into view.

The US dollar turned bullish again in September as the tax plan starting moving forward and odds of a December rate hike strengthened. Looking ahead into 2018, while tax cuts, if passed, would at the very least reinforce the current uptrend, the longer-term prospect for the dollar would depend on whether wage growth – a key factor for Fed policymakers – starts to show convincing signs of a pickup, and the scale to which any fiscal stimulus would lead the Fed to revise up its rate path projections.

 

 

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source: XM

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