European nations appear concerned about the competitive advantage America may regain
By J. Richard Fredericks, Main Management
If one believes, as we do, that a tax cut will unleash capital spending which, in turn, would spur productivity, GDP growth, job growth, and wages, is it possible that success in the United States could help the global economic prospects as well?
President Reagan cut the individual tax rate from 70% to 50% in his first term and then to 28% in his second term. Regrettably, however, after the corporate rate was reduced from 46% to 34% under Reagan (see here) it rose to 35% in 1994 where it has remained ever since despite the fact that other OECD countries have lowered their rates toward 20%. That reality can be seen in the chart below as many of the world’s largest countries have been cutting rates and since the amount of taxes ‘collected’ actually increased after the reductions. As a result, many nations have been emboldened to reduce their tax rates further still.
As can be seen from the Cornerstone Macro chart below, the United States currently has a combined rate of 39% consisting of a 35% federal tax rate plus the average tax rate amongst the states while others in the OECD have a rate of only 25%, which is 14 points or about 35% lower on a stated basis.
Indeed, the next chart below clearly delineates that virtually all of the OECD countries have dropped their rates since 2000 and lowered them even further since 2008. The rare exceptions have been the USA, Norway and Chile.
In late 2016, OECD published its annual report and noted that Japan, Spain, Israel, Estonia, and Norway (one of the exceptions in the chart below) all lowered their tax rates on corporate profits in 2015. Meanwhile, future reductions have been announced by France, Italy, and the UK, and even Japan is considering cutting again. The OECD went on to say that the average tax rate for corporate profits declined from 32% in 2000 to 26% in 2008, after which time, the rate of decline slowed. While the overall 2016 figure was similar at 25%, the OECD stated that the downward trend now appears to be picking up steam again.
So what may happen after our country cuts it tax rates?
In our view, the big potential positive surprise that will surface from the tax bill will be, not just the repatriation of funds by American companies, but the movement of foreign companies to locate operations within our shores. The just reported US Q3 GDP was $19.1 Trillion and the consumer portion was $13.4 Trillion, or 68% of the total. By far, our consumer market is the largest in the world and dwarfs the second largest consumer marketplace – China, where the consumer contributes around $4.3 Trillion to their economy. We believe that many foreign companies will want to locate operations here because of the attractive size of our market; because they sell their products here; and/or hope to sell their products here; and because the lower tax rate makes it more favorable to operate here as well.
Other countries have already spoken up about how the US proposed tax rate will impact their countries and what they intend on doing about it. The Epoch News (see here) noted that the US tax cuts “have Beijing in a bind” as both the “generous reductions in the corporate tax rates and the rationalization of the global tax scheme are expected to draw capital and skilled labor back to the United States.” Chen Pokong, a Chinese current affairs analyst said that “a large amount of American money, technology, and skilled labor is in China. Now American investment will leave China. For the Chinese government, this is no small shock.” Liu Shangxi of China’s Ministry of Finance noted that “We should plan for contingencies […] the next step for China must be to introduce tax reduction reforms.”
In Europe, Germany, France, Britain, and Spain have all written to Treasury Secretary Steven Mnuchin that the planned tax rate changes run afoul of treaties that could distort international trade. We are skeptical about the trade argument and believe it is really an opening salvo that indicates their displeasure about the advantages that the lower rate means for the US. Specifically, the Germans are the most worried about our prospective lower tax rate and other Europeans are complaining about a “race to the bottom”. They should be worried. At the current proposed 21% tax rate, the stated US corporate tax burden will be 30% lower than Germany, 39% lower than France, 16% lower than Spain and within striking distance of the UK (21% vs.19%). Why wouldn’t that represent a shift from a disadvantageous position (favorable to Europe) to a more competitive position (favorable to the US)? We believe it does.
It also positions us well against Mexico where the US advantage will be 30% (21% vs. 30%).
Overall, a stronger US economy can be a positive for the rest of the globe as we once again reassert ourselves as the engine of economic growth for the world. To keep up, many countries will be pressured to cut their own tax rates or move to our shores which we believe will unleash a broad-based prosperity, hopefully similar to the notable advances in growth and prosperity made after the Reagan/Thatcher cuts in the 1980s.
J. Richard Fredericks is founding partner at Main Management, a participant in the ETF Strategist Channel.
A pioneer in managing all-ETF portfolios, Main Management LLC is committed to delivering liquid, transparent and cost-effective investment solutions. By combining asset allocation insights with smart implementation vehicles, Main Management offers a unique approach that translates into distinct advantages for our clients, including diversification, cost efficiency, tax awareness and transparency. http://www.mainmgt.com.