US President Donald Trump is about to deliver his "big, beautiful Christmas present" for the people of America - or so he believes. This is the Tax Cuts and Jobs Act (TCJA), which has just been passed by both Houses of the US Congress and which Mr Trump will soon sign into law.
Its highlight is the slashing of the US corporate tax rate to 21 per cent effective next year, from the current top rate of 35 per cent, coupled with temporary tax cuts for most individuals.
This will be the most significant legislative achievement of Mr Trump's presidency so far, but it is controversial to the point of being politically polarising, and its impact will be decidedly mixed.
There are three aspects of the TCJA that are worth examining: its broad economic impact, its corporate and market impact, and its political implications.
Tax cuts can be expansionary and are best done when an economy is weak. But the US economy is buoyant. Its recovery from the 2008 to 2009 financial crisis is now in its eighth year. Growth is running at an annual rate of 3.3 per cent in the third quarter of this year and unemployment is low at 4.1 per cent and falling. Thus, as Mr David Lafferty, global chief market strategist at Natixis Investment Managers, puts it, the TCJA "is like throwing a small cup of gasoline on a fire that's already burning fairly well".
Its expansionary impact will also be limited by the fact that it is unlikely to add much to demand. According to an analysis by the bipartisan Joint Committee on Taxation, the individuals who most stand to benefit are those in highest-income groups and business owners, who have a lower propensity to spend additions to their post-tax earnings. The average individual in the richest 1 per cent will get a tax break of more than US$50,000 (S$67,273) while middle-income taxpayers will see an average tax change of less than US$1,000. Most low-income taxpayers will face higher bills. The positive demand effect will also be limited by the fact that except for companies, the tax breaks are temporary: they expire after 2025.
While Trump administration officials claim the tax cuts will "pay for themselves" by boosting economic growth, there is hardly an independent economist who believes this. Most see, at best, a marginal increase in growth that will not be enough to offset the revenue losses. Thus the tax cuts will add to US fiscal deficits to the tune of 0.6 per cent of gross domestic product per year, according to the Congressional Budget Office, as well as to debt. It remains to be seen how Republicans will react when the deficits (to which they claim to be opposed) start to go up.
The impact on corporate finances from the tax cut will be positive - although this should not be exaggerated as in practice, many US companies enjoy lower effective rates than the current headline rate of 35 per cent because of various exemptions and loopholes.
The impact on corporate finances from the tax cut will be positive - although this should not be exaggerated as in practice, many US companies enjoy lower effective rates than the current headline rate of 35 per cent because of various exemptions and loopholes. How much companies benefit will vary by industry - companies in real estate, the energy sector, mining and manufacturing for example, are expected to enjoy higher benefits than those in most other industries. Some of these companies could use the extra money to buy back stock or boost dividends - which would be good for their share prices. The US stock market could also benefit - although the widely expected tax cuts might, to some extent, already be priced in.
Companies that have a lot of money parked outside the US - such as Apple, Microsoft and Google, who between them are reckoned to hold about US$500 billion - stand to get a windfall. Under the new tax law, they would have to pay a one-time tax rate of only 15.5 per cent on their overseas liquid holdings instead of 35 per cent if they were to bring the money back under the current tax rules. In future, more US firms could be incentivised to repatriate overseas holdings back home.
This raises an issue which concerns Asia. Would US companies repatriate more of their profits from the region - or even "re-shore" operations back to the US and if so, would the US dollar rise relative to Asian currencies? Economists doubt this. Low tax rates are not the main reason why multinational corporations (MNCs) invest in Asia: proximity to markets, labour costs, infrastructure and business-friendly regulations matter more.
However, tax benefits offered by Asian countries to American MNCs will probably be less attractive than before. As to whether profit repatriation from Asia will lead to a stronger dollar, economists point out that this, too, is unlikely. Profits by US companies held in Asia are already denominated in US dollars. But it could be a different story for profits held in Europe - some portion of which might be held in euros.
So in short, the new US tax laws are unlikely to have much of a negative impact on Asia, although Asian countries could be hurt by other US policies, such as rate hikes by the US Federal Reserve - which would feed through to Asian interest rates - and protectionist measures, such as those the Trump administration is contemplating against China, in particular.
Finally, and not least, the tax cuts could have serious political implications. They have been bitterly opposed by the Democrats in the US Congress, not a single one of whom supported the legislation and who have variously described it as "a travesty" (Senator Cory Booker of New Jersey), "highway robbery" (Senator Tim Kaine of Virginia), and "an all-out looting of America" (House Minority leader Nancy Pelosi).
These sentiments seem to resonate with the majority of the US public. According to a CBS news poll, 53 per cent of Americans oppose the tax cuts, compared with 35 per cent who approve. People, on average, see the new tax law as likely to benefit large corporations, the super-rich, Wall Street investors and big political donors. Some 44 per cent think it will hurt their families, while only 24 per cent believe it will help. Other polls show similar results.
If such sentiments (combined with Mr Trump's poor approval ratings) persist or get worse over the next couple of years, the Republican party could face an uphill battle in the mid-term congressional elections in 2018. Should they lose their majority in one or both Houses, the Trump tax law could become a political target. There is thus reason to doubt not only its effectiveness, but also its longevity.
Correction note: The article has been edited to correct a typographical error.
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