US tax reform and impact on the rest of the world

I had just finished a presentation for the Intermodal Europe in Rai, Amsterdam on 28 November, on the subject of “De-globalisation of Markets’ and was still confident that world trade would grow better from 2018 onwards. The next day I saw the US Dow Jones industrial average storm above the 24,000 mark for the first time on 29 November as investors reacted joyously to news that the US Senate appeared close to passing its tax overhaul bill.

A snap shot of US corporate tax structure

The US federal tax rate for corporations is 35% - considered the highest in the OECD. But is said that a few businesses in the US actually pay the top rate, thanks to deductions and other loopholes. The effective tax rate for big corporations is actually around 22%, according to the US Treasury Department reports. US senators last week passed a sweeping tax cuts bill, paving the way for Donald Trump’s first big legislative victory which he promised during his election campaign. 

The Trump/Republican plan now would lower the official rate to 20%, which may bring down the actual to an even a much lower figure giving big US corporations a message from President Trump to move the profits and jobs back to the US from foreign territories.

The new rates would be lower than in Australia (30%) and similar to the United Kingdom (about 19%), as well as many other countries in Europe.

This reform is considered the biggest overhaul since the 1980s done by late President Reagan which created 20 million jobs across America in that period. US national debt being around 93% of GDP passed $ 20 t earlier this year. The new plan sees a sharp cut in corporation tax, but a senate committee finding has warned it would add $1tn and increase debt to GDP ratio to around 98% which may have other negative effects.

Whilst it is extremely difficult to say, what will happen, economists are now talking of the Laffer Curve (the Laffer Curve is a theory that states lower tax rates boost economic growth, the curve is used to illustrate Laffer’s main premise that, the more an activity such as production is taxed, the less of it is generated. the theory was developed by Economist Arthur Laffer in 1979).

However, the idea behind the Trump presidency is clear, “America first” and the tax cuts for the big corporations are expected to yield high investments, bring back profits without penalties from tax havens and create new jobs in America.

What happens to the rest of the world with the reform?

According to Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research: “A lower corporate tax rate and the shift to a territorial system would increase the flow of capital to investment in US corporations from abroad and from capital investments in owner-occupied housing and in agriculture. This would raise productivity and GDP, leading to increases in tax revenue that would partly offset the direct effect of the corporate rate reduction. In short, the congressional legislation that is likely in the months ahead will change the tax rules for US companies, but it will also have important effects on international capital flows. It could also have significant effects on tax rules around the world.” 

Greater trade ties with US, important for Sri Lanka

It is extremely tough to forecast the immediate impact for a very small economy like Sri Lanka, but the global financial markets will start reacting during the coming weeks to different scenarios. The developing nations including Sri Lanka will have an impact and will have to re look at its own direction and strategy as well as tax structure to attract global FDI and increase exports as the US is also expected to increase interest rates in the coming 12 months. 

If the US GDP growth accelerates the chances of increasing exports from a country like Sri Lanka will be higher. But the country will have to uplift its business environment and competitiveness to keep phase with a global response that will definitely sprung up in all countries to face the new environment in the US.

Keeping in mind a track record of slow reforms and implementation as a country, Sri Lanka will have an opportunity as well as a new challenge to move forward with this new development in the US. The Government must be fully focused on its vision and make the country an attractive trading, logistics and a financial hub that can add value to the international supply chains and be part of the global value chain if Sri Lanka need be the Indian Ocean hub. 

At the same time whilst we are negotiating many Free Trade Agreements, that would help the country’s market access, in my opinion it is important that we work out some preferential arrangements similar to EU GSP+ with Uncle Sam to get better market access, as the US will be a very important trading partner for Sri Lanka to develop its exports to a comfortable level from its current position. 

(The writer is the CEO of Shippers’ Academy Colombo, an economics graduate from the Connecticut State University USA, former chairman of the Sri Lanka Shippers’ Council and immediate past Secretary General of the Asian Shippers’ Council.)