US tax cuts fuel short-term growth

02 Mar 2018

The US economy is expected to accelerate further in 2018, with recent tax cuts boosting growth by 50 basis points.

The effect may be short-lived, however, with many tax breaks phasing out after 2019, flattening or reducing GDP growth in subsequent years.

“This year will see the best of both worlds: a reduction in the headline tax rate, but also all the deductions and tax breaks in place," says Macquarie North America economist David Doyle. “Then from 2019 and beyond, you move slowly back to reality."

Macquarie has increased its US GDP growth forecast for 2018 to 2.6 per cent from 2.3 per cent. The economy expanded 2.5 per cent in 2017.

“Tax reform provides a slightly stronger boost to the economy than we had anticipated," says Doyle.

Consumers fuelling expansion

Fourth quarter economic data underscored the strong footing of the US economy as it continues its eight-year expansion.

Consumer spending reached a three-year high in the fourth quarter, with a measure of domestic demand expanding at 4.6 per cent.

Housing investment also contributed to better than expected economic data for the period.

Doyle sees continued growth in these two areas, aided by falling unemployment and a rise in real wages.

He says consumer spending may increase by nearly $US140 billion as a result of recent personal tax cuts announced in the largest overhaul of the country's tax code in 30 years.

Business profits to rise                            

As part of the tax reforms approved by Congress, the corporate tax rate will be reduced to 21 per cent from 35 per cent.

Congress estimates that from 2018 to 2027, US company tax revenue will be on aggregate $US654 billion less than would have been the case under the previous tax system.

The tax savings will significantly increase profits for US companies in 2018.

Macquarie expects pro forma earnings in the Standard & Poor's 500 Index to climb by approximately 15 per cent after taxes this year, 7.7 percentage points of which are a result of the lower tax burden.

While the tax cuts will provide a substantial boost to 2018 growth, the positive effect will diminish from 2019 onwards.

The Penn Wharton Budget Model has estimated that the effective corporate rate – or the real rate after deductions, provisions and income deferral strategies – will fall to 9 per cent in 2018 from 21 per cent.

But as many of those tax breaks phase out after 2019, the effective corporate tax rate will bottom in 2018 and may average 17 per cent from 2022 to 2030.

Doyle says lower taxes and new fiscal incentives on repatriation of American profits earned overseas will not necessarily boost corporate investment, which he says is already stretched in some segments.

Macquarie's analysis suggests the commercial services, homebuilding, banking and diversified financials sectors stand to benefit the most in the long term from the decline in the effective corporate tax rate.

For a copy of the report US tax reform, contact your Macquarie representative.

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