The Tax Reform Act, the Sugar Rush and the Crash

America poses the “biggest risk to rock the global boat” – The Economist

While the “party of no” (Democrats, obviously) looks on in horror, the President is reveling in the glow of what passed for a foreign policy/security speech (12/18) and a tax reform act that no one clearly understands passed both houses of Congress (by 12/20). The President has indicated he will joyfully sign it into law. On security, going off his own script – which focused on North Korea and Iran as military threats and Russia and China as global “unfair” competitive threats – Trump bragged about a stock market that is up solely because of tax cuts and about Putin’s gratitude at a CIA thwarting of a terrorist attacked planned against Russia. Climate change, a national threat for years including in a defense bill signed a couple of days before, was notably absent. So what did Trump’s security presentation say about these two global powers?

“Russia and China are referred to as ‘revisionist powers’ that are trying to reshape a world ‘antithetical’ to U.S. interests and values via ‘technology, propaganda and coercion.’ The administration is signaling to Russia and China that the Trump administration recognizes the ‘gray zone’ battlefield and that such acts will be responded to if they take liberties in cyberspace or in the marketplace.” The Cipher Brief, December 19^th. China chimed back quickly, effectively accusing Trump of lying and reawakening the Cold War. The official Russian response mirrored China’s.

But Trump is focused on his one and only legislative “success”: the tax reform bill. The ten thousand pound gorilla. And gloating and smiling Republicans paraded before the press. “Promises kept.” House Speaker Paul Ryan, with a straight face, told Americans how much better off most of us will be as a result of this abomination. The Swamp scored big.

Yet the stock market fell as this bill cleared the House, despite the fact that most publicly-traded companies’ valuations are predicated on the tax cut. With polls showing that most Americans oppose the tax bill, one of the least popular pieces of seminal legislation in American history, it passed along party lines. 83% of the tax benefits accrue to the top 1% of American earners; Trump clearly also broke his promise to eliminate the “carried interest” benefit that allows mega-wealthy hedge fund managers to avoid paying taxes at the same rates as their secretaries.

That the President hit the lowest “first year” presidential approval rating since such polls were first conducted (starting with Dwight Eisenhower in 1953), that most Americans are very wary of a tax cut for the wealthy with a massive resulting deficit and a promise to reduce programs (like Social Security and Medicare) is anything that they want, still Trump was all smiles. He even told the world that he has no intentions of firing special counsel Robert Mueller, even as signs point to a drilling down towards son-on-law, Jared Kushner. At a White House gathering on the morning of December 20^th, Donald Trump also gloated that the new tax act, in rejecting the individual healthcare mandate, has finally repealed Obamacare.

That tax reform act, 100% Trump/GOP, was his moment of legislative triumph, even though the vast majority of neutral economists have long since rejected the trickle-down theory (a rising tide floats all boats) upon which the tax reform act is based. American policies are already drawing responses from other countries, ready to capitalize on our missteps.

 

Even as Republicans tell us that the tax reform will push U.S. companies to bring their intellectual property back to the United States to create jobs, a lot of tech-driven companies plan on doing just the opposite because of another Trump policy: “Last week [2^nd week in December], the Department of Homeland Security published a set of proposed rule changes that would make the visas even harder to qualify for, to ensure that only ‘the best and brightest’ foreign workers were selected. It also hoped to eliminate a work permit for spouses of some of these visa holders [dump your spouse and come to the US?!].

“In contrast, Canada’s immigration agency in June started the Global Skills Strategy for high-skilled workers from abroad to get a work permit in two weeks… ‘That is, excuse my English, goddamn fast,’ said Hubert Bolduc, the chief executive of Montreal International, a public-private partnership that recruits foreign companies to move to Canada and offers support once they arrive in Montreal. ‘We’ve been loving government on this because we know it’s a talent game.’” New York Times, December 19^th. Tech-driven American companies are planning to more even more research and development off shore.

I’ve focused a lot of late on the domestic consequences of this tax bill. Today, with a little help from the BBC, however, I’d like to take a quick look at how our tax bill, now passed and signed into law, is likely to be received by others in the rest of the world.

Clearly, a reduction in corporate tax rates, if sustainable, would make the United States a better place from which to do business simply on a cost basis. But there are little bells, whistles and triggers in that tax reform legislation that might just provoke some angry responses from other countries and just might place the United States in violation of international tax and trade agreements to which it has been a signatory for a long time.

“[Some] of the new items - including a perk for exporters - may breach international rules and treaties… European finance ministers have already voiced concerns about some of the plans… The US is likely to face challenges to some measures and the combination of changes could pressure other countries to rewrite their own rules, perhaps by lowering taxes, said Reuven Avi-Yonah, a law professor at the University of Michigan… ‘It's kind of turbulent waters ahead,’ he said. ‘The real question is, how will other countries react?’

“The US Congress [is] signing off on what will be the most sweeping overhaul of the tax code in a generation… Tax attorneys have predicted it will take at least a year to understand the implications of the international changes… ‘This stuff is not going to go down like chocolate sauce,’ said David Rosenbloom, an attorney at Caplin & Drysdale and a former tax official…

“To offset the revenue losses, the US is imposing a one-time tax on profits held abroad, levied at 15.5% for cash and 8% for illiquid assets… Depending on your perspective, the measure either captures tax that firms otherwise would have avoided, or provides companies with a major break on what they would have otherwise owed… ‘Allowing them to pay a low rate is basically a get-out-of-jail halfway free card,’ said Matthew Gardner, senior fellow at the Institute on Taxation and Economic Policy, a left-leaning Washington think tank…

“To discourage unfair profit-shifting in the future, the US is imposing a new minimum tax of about 10% on global intangible income - such as patents - and toughening rules related to payments to foreign subsidiaries… Those provisions are expected to hit pharmaceutical and technology companies, which currently avoid taxes by booking profits attributable to technology in low-tax jurisdictions…

“Because the minimum tax is calculated on a global basis, it also does little to counter the appeal of tax shelters, they said… ‘I don't see this as raising tax burdens for very many, especially by the time this all gets through,’ said Kimberly Clausing, a professor of economics at Reed College.

“Tax attorney Robert Misey, who leads the international department at law firm Reinhart Boerner Van Deuren, said he thought there might be opportunities to circumvent the new levies… And, he noted, some of the provisions apply to companies with more than $500m in revenue over three years - those that can most afford savvy tax advice…  ‘Let's face it,’ Mr Misey said. ‘Those are the companies that are going to try to figure out every angle to avoid it.’…

“The bill allows US companies to claim a deduction for money earned from exports, in effect lowering the rate on exports to about 13%...That change is likely to be seen as an illegal subsidy by the World Trade Organization and could lead to challenges… ‘I would expect foreign countries to be somewhat aggrieved by this statute,’ said Caplin & Drysdale's Mr Rosenbloom, who added that policymakers were using the US tax plan for ‘isolationist’ goals.

“The new plan also increases the tax liability of US subsidiaries that make payments to foreign firms. That measure has companies in places such as Germany worried… Prof Clausing said she thought those rules were vulnerable to challenge - or negotiation - and could be designed to strengthen the hand of the US in international discussions about taxes… ‘Many people view that as a more of a political gambit,’ she said.” BBC.com, December 19^th.

OK, lots of this stuff is pretty technical, so let me bottom line you on what all this means: short-term, there will be tax cuts that just might make most folks (except those living in high state tax states) happy for a moment. But that mega-trillion dollar deficit addition looms large. The cost of living for most of us, tax cuts notwithstanding, is going to rise. And as health insurance premiums begins to increase, as mergers and acquisitions result from all that new corporate cash generating lots of layoffs, as discretionary spending from high income tax states drops and as Congress cuts social programs (like Medicare and Social Security), we are likely to see a recession… which will roll globally very shortly. We can also expect to see challenges under World Trade Organization rules to the discriminatory aspect of the tax bill, and we can expect other countries to erect new trade barriers and tax schemes to counter ours.

2018 is likely to be the year of “tax confusion,” as an IRS with a 23% staffing cut that has to deal with an entirely new tax code. Tax lawyers and accountants are giddy. Will the resulting damage fully manifest by the 2018 mid-terms? That is anything but clear. GOP candidates have to hope that there are enough folks who actually get a meaningful tax reduction who care about little else. And in that group, are there enough stupid voters out there who would believe that borrowing money (the deficit) is the same thing as earning it… that it is an interest-free loan with no consequences? Unfortunately, there probably are.

High income tax states could throw a monkey wrench into the works by allowing their individual taxpayers to “donate” to the state and receive a one-on-one credit against state income tax in return (which may be challenged by the Trump administration). This would allow high income tax states to level the playing field enjoyed by low or no income tax states… on that nasty disallowance in the new bill of high level state personal income taxes as a deduction against federal income tax… but allowing deductions for charitable causes.

By 2019, the chickens will have roosted, and we can expect the 2020 elections to be particularly vituperative as a result. If the Dems can even figure out what they stand for… versus against.

I’m Peter Dekom, and we have just created one of the costliest economic messes in American history, accelerating income inequality as we have never seen before.