Market Bulletin - Taxing times
Just shy of 100 days in office, Donald Trump announced his tax plan, as US and UK economic figures lagged expectations.
“The hardest thing in the world to understand is the income tax,” said Albert Einstein. Since then, it has only got harder, not least in the US. Gary Cohn, the chief economic advisor to the president, reminded press last week that the current US tax code comes with 211 pages of instructions – and costs Americans seven billion hours in compliance work each year.
The reminder came as Donald Trump’s long-awaited tax plan was announced, which aims both to simplify US taxes and, crucially, to cut them drastically. Under the reforms, the current seven tax brackets would be reduced to just three; the top rate of US income tax would drop from 39% to 35%; and the headline corporate tax rate would fall from 35% to 15%.
Given its centrality to his election platform, he might have been disappointed that the market responded with little more than a whimper. Goldman Sachs commented that market sentiment might have been too negative, as there was a good chance the plans would become law, but JPMorgan Chase warned that the president’s plan was “virtually impossible to pass”.
Either way, it seems that markets may have already priced in a programme of tax cuts, making the news itself simply a confirmation of expectations, rather than a chance to reignite investor enthusiasm. Nevertheless, pushing it through Congress will be a tall order, in large part because it divides Republicans between two leading party priorities: low taxes and deficit reduction. Calculations show that the income tax cuts would reduce government revenues by $5.5 trillion over ten years, while the corporate tax cut would reduce it by $2.2 trillion. Few deficit hawks accept that increased growth would sufficiently compensate the US Treasury.
In fact, markets had been broadly buoyant earlier in the week, following the accession of Emmanuel Macron into the second and final round of the French presidential election, and as quarterly earnings continued to trickle in. In Europe, the Eurofirst 300 rose 2.4%, largely thanks to the Macron news, although some company results also helped. Total, the French oil major, announced healthy results. There were broader reasons for bullishness, too, as figures showed unemployment continuing to drop across the continent – and eurozone factory growth hit a six-year high. France’s first-quarter growth underwhelmed, but Spain reported expansion by an impressive 0.8%.
The S&P 500 rose 1.6% last week, and the tech-heavy NASDAQ hit 6,000 for the first time in its history, helped on its way by encouraging results from Apple and Alphabet (Google’s parent), the two largest listed companies in the world. Although US markets ended the week a little more cautiously, leading indices were sitting not far short of record highs.
Yet among the landmark numbers to reflect on, it was a political figure that drew the greatest interest: 100 days. On Saturday, Donald Trump’s presidency reached the landmark commonly used in the US to assess the trajectory of a president’s incumbency. In Donald Trump’s case, indicators vary. Markets appear to have enjoyed the journey thus far, and consumer confidence in the US is at a 17-year high. Trump’s tax plans start the ball rolling on a windfall for many companies. (The plan also includes a significant repatriation package for companies returning operations to the US.)
Growth figures, on the other hand, offer a somewhat different assessment. US GDP figures released last week showed that the economy had grown by just 0.7% (annualised) in the first quarter – the lowest reading in a year. Consumption growth stooped still further to 0.3%, a far cry from the 3.5% it struck the previous quarter and its lowest rate since 2009. Trump’s approval ratings – which matter in terms of whether his policy plans prevail – are below average, but not disastrously so. Analysts might like the 100-day watershed, but they will probably have to wait somewhat longer to make a meaningful assessment.
Theresa May has been in office for almost 300 days, but her own policy plans remain somewhat unclear, although the Conservative Party manifesto should provide some pointers. Last week, however, there was a handful of significant comments, not least over pensions, in a week when HMRC figures showed that pension freedoms withdrawals have now surpassed £10 billion since their introduction two years ago. At PMQs last week, she was once again asked whether the ‘triple lock’ for pensioners remained secure. She made clear, once again, that it did not – and did so again in a BBC interview with Andrew Marr over the weekend.
The alternative reportedly under consideration is a paring down to a ‘double lock’ that dispenses with the 2.5% minimum annual rise in the State Pension. Several leading experts have long raised questions over the sustainability of the triple lock, and there are further questions over whether it skews state provision too far towards the elderly. Last week, the OECD made its own contribution to the debate, arguing that countries should not provide state pensions for the wealthy. At any rate, the triple lock’s imminent demise looks increasingly likely, which may please the deficit hawk resident at 11 Downing Street.
Yet despite all his instincts, the chancellor has decided to shelve the planned cut to the money purchase annual allowance (MPAA) – the amount that those already flexibly accessing their benefits can contribute tax-free each year to their pension. He has also dropped plans to cut the tax-free dividend allowance for the moment, in order to help the weighty Finance Bill 2017 pass through parliament as swiftly as possible before it closes for the general election. This could push the MPAA changes back by as much as a year.
The change would have cut the MPAA from £10,000 to £4,000 from April, while the tax-free dividend allowance reduction from £5,000 to £2,000 was to be made from April 2018. It remains to be seen whether the government will propose the dividend change again after the election, so that it takes effect when originally planned. Nevertheless, there was heavy criticism levelled at the government last week over its postponement of the plans, and the confusion savers are being caused.
There was good news for the Treasury, however, in the form of the latest UK deficit figures, which have reached their lowest level since the financial crisis. The government borrowed £52 billion in the last financial year, a significant sum but down by £20 billion against the previous year. The FTSE 100 ended the week up 1.3%.
In contrast to the deficit news, economic figures for the first quarter showed that the UK economy slowed to a mere 0.3% growth rate in the first quarter, down from 0.7% in the previous quarter and its lowest reading in a year. Services output dropped significantly, while manufacturing provided the highlight. The cause was widely agreed to be inflation, spurred by the post-referendum drop in the pound. Major banks such as Lloyds and ING expect UK inflation to surge close to 3% by the end of this year, which would hit the UK’s beleaguered cash savers still harder.
Meanwhile, the EU-27 met at the weekend to prepare for Brexit negotiations and agree a common position. Yet UK–EU relations were complicated after Jean-Claude Juncker’s dinner at 10 Downing Street left him “ten times more sceptical than…before” about prospects for the forthcoming Brexit negotiations, according to reports in the German press. Mrs May dismissed the claims as “Brussels gossip”.
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