Will Trump’s proposed tax policy work?

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Undoubtedly one of the most talked about events of 2016 was Donald Trump’s successful run to the United States (US) presidency.

Widely publicised throughout Donald Trump’s campaign was his ongoing commitment to “Make America Great Again”, to be achieved largely through his innovative economic policies, with a specific focus on reforming tax policy.

Despite President Trump having begun the roll-out of other policies, he is yet to act on his proposed tax reform. However, significant changes to the US tax system appear to be on the horizon.

The US currently imposes one of the highest corporate tax rates among the world’s advanced economies, stinging businesses for up to 35 percent tax on their profits at the Federal tax level. In addition, businesses have to fork out State taxes that can be as high as 13 percent, depending on the state.

This tax rate is much higher than New Zealand’s own corporate tax rate of 28 percent and the global average corporate tax rate, which is approximately 25 percent.

President Trump has vowed to cut the US corporate tax rate by more than half, from 35 percent to 15 percent. This low tax rate will apply to businesses of all sizes. President Trump’s belief is that a lower tax rate will encourage US companies to return their profits back home, boosting investment and creating more jobs for Americans.

This move would bring the US into line with many other countries, like New Zealand, who recognise that implementing a lower corporate tax rate and reducing barriers to investment are important for encouraging overseas investment and stimulating the domestic economy.

A peculiarity of the US tax system is its method of taxing the income which US companies earn overseas, which dates back to a system of worldwide taxation established more than a century ago. US companies currently pay up to 35 percent corporate tax on all income, whether earned in the US or overseas. However, US corporate tax on foreign earnings is generally deferred until the earnings are returned to the US.

When the foreign income is returned to the US, the company is taxed in the US. The company is generally allowed a credit against its US tax liability for any foreign tax paid on the income, however the company will still often be required to top this up to the US tax rate to satisfy its US tax liability.

In order to defer this tax burden, US companies often hold these profits offshore. This contrasts with many other OECD countries, including New Zealand, which allow foreign subsidiaries to return earnings to their home countries with no tax due. In New Zealand it is only when the New Zealand parent company returns these profits to its owners that tax is paid by the owners at their own tax rates.

The high US tax rate, combined with its archaic method of taxing foreign earnings, creates a “lock-out-effect” whereby US companies are discouraged from returning profits earned overseas.

President Trump believes that this puts the US at a distinct disadvantage in the global economy and plans to address this by introducing a 10 percent repatriation tax on overseas corporate profits. At present, profits returned to the US are taxed at the full US corporate tax rate.

President Trump does not provide specific details around how such a policy may work, however it appears the aim is to lure multinationals into returning cash back to the US with the promise of a reduced tax bill at home. Earlier in his campaign, President Trump’s tax plan called for the repeal of a tax deferral on overseas earnings of US-based companies, which could perhaps be achieved by implementing a regime similar to that of New Zealand. While his current policy may provide some incentive for US companies to return profits home, it does not prevent companies continuing to defer the tax on foreign earnings.

President Trump has also vowed to lower individual income tax rates, while also promising to ensure “the rich pay their fair share”. US workers can expect the seven tax bracket system to be cut to three tax brackets, with the rates set at 12 percent, 25 percent, and capped at 33 percent.

The new brackets are broadly similar to those currently in place in New Zealand, where there are four tax brackets with rates ranging from 10.5 percent to 33 percent. Despite each income earning group set to benefit, it would appear that the rich stand to benefit the most. President Trump insists the policy is designed to ensure that the wealthy contribute their fair share, but prevents anyone paying so much so as to destroy jobs and reduce the country’s ability to compete.

Commentators have suggested that an enhanced US economy would lift economic growth around the world. This would be a welcomed boost, following a year in which world economic growth rose at the slowest rate post-recession. However, history shows that previous US tax reforms have had little impact on the wider economy or on Americans facing hardship. Typically, it is the owners of large companies which tend to benefit the most from profits being returned home, rather than the average taxpayer.

The US is estimated as being the biggest trading partner for nearly a quarter of the nations worldwide, and with President Trump’s desire to renegotiate trade deals, the desired economic growth to be achieved through his tax policy could well be unrealised.

As for New Zealand, the US is the third largest recipient of NZ goods and services, and with the recent withdrawal by the US from the Trans-Pacific Partnership this could well be affected. With President Trump suggesting the US negotiate individual trade deals with countries, including NZ, the impact of any ongoing and future President Trump policies can at this stage only be met with speculation.

It has been estimated that President Trump’s proposed changes have the capacity to boost economic growth in the US by an average of 3.5 percent per year, resulting in the creation of 25 million jobs over the next decade. With President Trump’s election victory, it appears many Americans were sold on the idea of a prospering economy and reduced tax rates. However, the crucial question which remains to be seen is the impact President Trump’s tax policy will actually have on the average American and the rest of the world.

The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.

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Grant Neagle

Grant Neagle is a director in the Tax Team at PwC. Email: grant.t.neagle@nz.pwc.com

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