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U.S. Tax Cuts: Pros and Cons

December 20, 2017 | Global/Emerging Markets


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Congress has passed a new tax bill, which will provide a significant corporate tax cut in the United States, and domestic sectors should benefit disproportionately. But tax cuts could have a longer-term impact on debt levels, which could negatively affect economic growth.

Pro: Domestic Sectors Benefit

The significant corporate tax cut in the United States will have some clear winners. As shown in the chart below, most domestic sectors, such as retail, telecommunications, and utilities, which have had a relatively high marginal tax rate, will benefit disproportionately from a corporate tax cut.

It is not surprising, then, that we have recently seen a rotation in U.S. equity-market performance away from high-tech, fast-growing companies and those with significant exports (which already enjoy relatively low tax rates) toward more domestic sectors.

 

Con: Longer-Term Slowdown?

Beyond the near-term stimulative effect of tax cuts, we should also consider their longer-term impact on debt levels and the sustainability of accumulated debt. As the chart below illustrates, the Congressional Budget Office (CBO) projects that at some point in the next five years, we will cross the 85% ratio of debt to gross domestic product.

The 85% ratio of debt to gross domestic product is a significant threshold because empirical studies suggest that at this level, we will begin to observe a meaningful slowdown in economic activity.

That is a significant threshold because empirical studies suggest that at this level, we will begin to observe a meaningful slowdown in economic activity. We do not know whether that will happen, but we should be mindful of it.