Trump’s corporate tax cuts will put pressure on both the UK and Europe

If the US has a 15 per cent corporation tax rate, that puts huge pressure on other governments to fall into line

Hamish McRae
Wednesday 26 April 2017 16:47
Trump has not yet announced his tax reforms, but a 15 per cent cut in corporation tax rate has been floated
Trump has not yet announced his tax reforms, but a 15 per cent cut in corporation tax rate has been floated

The Trump tax plan is revolutionary, and if it goes through in anything like the outline sketch, that revolution will resonate around the world. It carries a huge danger and we’ll come to that in a moment, but if it avoids that danger, how governments finance themselves in the second quarter of this century will be quite different from the way they finance themselves now.

Step back from the detail, which in any case we do not have yet, and focus on two elements: lower headline rates, and radical simplification. They link together, because if you have high headline rates you have to create loopholes to diminish the damage they do to economic growth.

Headline rates in the US are quite high by world standards. For example the top rate of personal income tax in California works out at 52.9 per cent adding Federal and state taxes together. But most people, even rich people, don’t pay anything like that because there are all sorts of loopholes. The US corporation tax rate works out at 38.9 per cent, the third highest in the world. But again, hardly any companies pay that because they too are given incentives that enable them to pay less.

Trump's 100 Days: Alec Baldwin's best bits on Saturday Night Live

But loopholes create distortions. In the US, the most notable of these is that profits of foreign subsidiaries, if left abroad, are untaxed. Headline rates matter, even if in practice companies (and individuals) can to some extent get round them, because they create resentment.

Jean-Baptiste Colbert, the finance minister of Louis XIV said: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.”

The American tax system generates a cacophony of hissing without gathering that many feathers. Big tax cuts will stifle the hissing. The huge question is whether they will enable the US Internal Revenue Service to end up with more feathers.

We cannot know. We are only getting a set of principles. The immediate judgement will come from the financial markets, and their first reactions are often misleading. A 15 per cent corporation tax rate, would bring the US towards the bottom of the global league table, and would put great pressure on countries such as Ireland, which has used its 12.5 per cent rate to lure US businesses to relocate. It will also blunt the appeal of the current UK strategy to attract international business with low company taxation.

But whereas a small country can increase its revenues by cutting rates, a big one can’t – or at least not so easily. So assuming the corporation tax cut goes through, the US is embarking on a great economic experiment. It can’t gain much additional revenue from increasing its share of global corporations located there. The only thing that will increase, or even maintain the tax take, will be greater growth. Still, if the US has a 15 per cent corporation tax rate, that puts huge pressure on European governments to fall into line.

The personal tax changes appear more modest. I know that there are cuts for millionaires and on the surface these changes look regressive but in reality personal taxation will remain in the normal global band. In any case if most loopholes are closed, a big if, income tax revenue will be protected. The unusual feature of the US tax system is not on the personal income tax side but on consumption taxes, with very low fuel tax and no value added tax.

Indeed were it not for one thing, these plans look like a long-delayed and necessary set of reforms. Not perfect by any means, but revolutionary in their global implications.

That one thing is the extent to which these reforms can really deliver sustained higher growth. The US economy is pretty close to full capacity – there is a lively debate as to quite how close. If you push down the loud pedal on an economy that has already been expanding for more than seven years, what happens? Maybe an extra year of growth before the next downturn, but at the cost of a sharper recession when it comes? Wall Street is already at or close to its all-time peak. That does not mean it can’t go higher, but this does feel a bit like the dot-com boom in the late 1990s, doesn’t it?

At a microeconomic level these plans look both welcome and overdue. But at a macroeconomic level they carry big risks. I happen to think there is life left in the expansion, but a couple of years from now things will look rather different.

Join our new commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies

View comments