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What the US tax reforms mean for the global economy

Fresh concerns that the US Senate’s tax-cutting bill won’t pay for itself have pushed the high-profile reforms back to the drawing board and delayed a vote on what could be the largest overhaul of the system in three decades.

The landmark reforms could increase the deficit by $10 trillion over the next ten years, new estimates from the Joint Committee on Taxation show. This contradicts US Treasury secretary Steven Mnuchin, who is convinced the bill will generate $2 trillion of extra revenue.

Republicans want to slash corporate tax from 35%, the highest in the world, to 20% and provide some income tax relief to individuals.

Whilst some Republicans claim cutting taxes will stimulate economic growth, critics are concerned that slashing the government’s key revenue streams will hurt the economic outlook.

The new numbers from the Joint Committee on Taxation actually support both arguments, but clearly the Republicans felt pressured to modify the bill to try and get it quickly voted through.

Cutting tax to stimulate growth

Cutting corporate tax could generate $407 billion in additional revenue for the US government, the numbers show, which would lift economic growth by 0.8% over the next ten years – one point for the Republicans.

Unfortunately, this won’t be anywhere near enough to offset the $1.5 trillion of cuts targeted by the reforms – match point to the critics.

To appease these critics of the bill, a ‘trigger’ was included to automatically increase taxes if revenue targets are missed after the cuts. But the congressional watchdog dealt the US Senate a double-blow and barred the use of this trigger.

Earlier on in the week it looked like the US tax reforms were headed for a quick victory after support from Senator John McCain – but instead the vote was pushed back as senators were forced back to the drawing room to make revisions to the legislation.

Initial optimism helped support the S&P 500 and Dow Jones Industrial Average make history in November. The Dow closed above 24,000 points and the S&P 500 notched up an unprecedented 13 successive months of positive growth – that’s never happened in the 90 years since records began.

Fiscal and monetary policy

It’s crucial that the implications of this tax bill are properly considered, especially against a backdrop of surging public debt in the US.

The American economy has similar dynamics to the one in the UK – although gross domestic product (GDP) looks a lot healthier.

Whilst unemployment has reached pre-crisis levels and equity markets have been surfing a marathon bull run, anemic productivity is weighing on the economic outlook and potential for wage growth. The deficit outlook is a grey cloud on the horizon, and income and wealth inequality is rising.

That’s the scene that current Federal Reserve Chair Janet Yellen will leave behind to her successor Jerome Powell when her term ends in February.

Loose monetary policy has got global economies only so far in their recovery from their long recovery from the 2008 financial crisis. The question is whether it’s now time for fiscal policy to get as much attention?

Addressing the Joint Economic Committee, Yellen has warned that the rising tide of public debt, weak productivity and inequality should be at the heart of fiscal policy going forward.

Tackling low productivity

Policy makers are facing similar troubles in the UK, as they grapple with how to boost productivity, which has lagged behind many other economies since the financial crisis. Productivity demands investment in infrastructure, which is determined by fiscal policy.

It’s interesting to think about where we would be today if governments had put fiscal policy on the same pedestal as monetary policy during the recovery. With the cost of borrowing low, could investment in infrastructure have helped stimulate the economy better than pumping the markets with cheap money alone?

The US Fed has lead the pack on the path to monetary policy normalisation, and Yellen sees this gradual process continuing as the US tries to sustain a healthy labour market and keep inflation on target.

Powell is widely seen as a continuity candidate, and will likely remain on this path to try and avoid a cyclical boom and bust scenario when he takes the reigns in two months’ time.

What we do know is that investment in infrastructure, tackling growing levels of public debt and addressing inequality will cost money – money the US government may not have if these tax reforms go through as they are.

What does this mean for me?

Events in the US, and elsewhere in the world, can be hard to watch at times. But it’s important to keep an eye on the global stage – even if it is through the gaps in your fingers.

In such an interconnected world, the US still has a strong hold on global economies. As the old adage goes, ‘when America sneezes, the world catches a cold’. A stumble in economic confidence in the US could be felt in my very own wallet.

But investors still seem convinced that Central Banks are willing to loosen stimulus if such a wobble happens. This belief has underpinned the equity bull run but maybe it has created some excesses along the way. Low levels of volatility mean that markets have continued to march higher, despite being is some of the most uncertain times of a generation. So how should this impact your investments?

Diversification is the key. Investing could help you offset the impact of inflation on your savings, but you’ll need to spread your money across investments, asset classes and geographies to try and offset any losses with gains made elsewhere.

Perhaps more importantly is your time horizon. If you’re focused on the long-term, short-term fluctuations won’t keep you up at night and means you can focus on what’s important in life.  

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