Preparations needed to mitigate effects of US tax cut

By Tan Haojun Source:Global Times Published: 2017/12/7 22:33:40

Illustration: Peter C. Espina/GT

Following the tax overhaul recently approved by the US Senate, the corporate tax rate in the US will drop substantially, personal income tax will also be reduced, a number of tax systems will be simplified and a one-time tax will be levied at a lower rate on American companies' transfer of overseas assets.

It's inevitable that this tax reform plan will have an effect on the global economy and market. Some people claim there will be little effect, but such blind optimism can be dangerous. The impact of the US tax reform should not be underestimated.

The tax reform plan, to some extent, is one of the ways the US is harvesting the results of its previous quantitative easing (QE) program. When the US ended QE, it had not maximized the benefits from it. Because emerging economies and the EU had not experienced economic recessions, there were no capital flows back to the US. But the tax reform may have this effect and other countries may suffer capital losses as a result.

Some people believe that just as the policy of quantitative easing failed to deliver the full benefits expected for the US, neither will the tax reform. However, compared with quantitative easing, the tax reform is more targeted and more likely to produce the desired effect.

Tax reform at home is very appealing to US capital overseas. A group of multinational corporations in the US have large amounts of capital "deposited" in other countries to escape the high domestic tax rate. As soon as the tax reform is introduced, internationally renowned enterprises will change their money into dollars and may return some of their operations back to the US. Microsoft and Apple have already said they will do this. Undoubtedly, the side-effects on other countries will be significant.

For European countries, which have large amounts of debt, large capital flows back to the US will have a big impact and it may trigger a new debt crisis. This could also imperil the global economic recovery. Capital outflows will also make economic recovery harder for emerging economies.

Amid the global concerns about the impact of US tax reform, investors' confidence has also taken a hit, and this will undermine market stability.

Despite these concerns, preparations can be made to reduce some of the impact.

Taking the initiative to invest in the US would be one option. Since the tax reform may have a siphoning effect on global capital, this makes investing in the US a potential solution. If US investors can make money by withdrawing capital from the global market, investors from other countries can also make money by investing in the US. Hence, taking the initiative is the best defense against risk.

On this basis, we can introduce policies to encourage domestic enterprises and investors to increase their investment in the US and make up for the shortfall from capital outflows. Because capital outflows can bring about market volatility and reduced investment, it also leaves more space for domestic investors. After all, the introduction of the tax reform will not lower the labor costs in the US. Emerging economies can compete with the US with their labor cost advantages and start a new round of competition.

Also, adopting the same tax reduction policy as that of the US is another possible measure that could be taken. The problem that may arise is that worldwide tax cuts may arouse greater risk of a new debt crisis. How to avoid debt risks caused by tax cuts is a significant issue that needs to be considered.

In short, the US tax reform will be a test of the global economy and the market. Serious contemplation is needed so that the market can maintain stability.

The author is a financial commentator from Zhenjiang, East China's Jiangsu Province.

Posted in: INSIDER'S EYE

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