Trump’s tax cuts impact European businesses

The U.S. president insists that their economy will ‘rock’ following his success in overhauling the tax code, but tax cuts could trip up its trade with its major partners.

The U.S. economy powered ahead impressively during 2017 and the forecast for the year ahead looks equally strong. Such is the bullish outlook that expectations for three further interest rate hikes from the Federal Reserve over the next 12 months to match those of the past year could prove too conservative.

President Trump confidently predicts that the economy will grow by three percent in 2018, a rate that increasingly looks achievable if the figure for the final quarter of 2017 hit four percent as predicted. Given this acceleration, it’s debatable whether the further shot of adrenalin that will come from the corporate tax cuts he signed into law shortly before Christmas is necessary.

Nevertheless, his insistence that the sweeping overhaul of the tax code and reduced individual and business taxes will make the U.S. economy ‘rock’ emphasises that it’s full speed ahead, despite its transatlantic impact. The possibility of conflict was highlighted a month ago when the finance ministers of Europe’s five biggest economies wrote to the White House and the U.S. Treasury Department to express their concerns.

According to the five, who include the U.K.’s Philip Hammond, Germany’s Peter Altmaire, and France’s Bruno Le Maire, the U.S. proposal to slash corporation tax on business profits from 35 percent to 21 percent would contravene international agreements and harm trade. It could also provoke retaliatory measures from the major Europe, Middle East and Africa (EMEA) economies.

There is particular concern that some provisions of the bill smack of protectionism and could result in the U.S. imposing double taxation of European companies. The letter refers to the possibility the reform would “discriminate in a manner that would be at odds with international rules.”

On a more positive note, U.S. business spending has been strengthening in anticipation of the tax cuts and the benefits will extend to Europe’s many SMEs with an American parent or partner.
Whatever the ultimate implications of this move are what is clear is that it’s placed a spotlight on how companies are using their cash. Whilst a significantly lowered tax rate may seem attractive, it may not be the best return on the cash.

In Europe, in particular, companies are considering a number of alternative initiatives with a better rate of return or a better use of cash from a business perspective:

  • The dawn of economic growth in Europe is starting to shed more light on potential investment opportunities. M&A activity has started to increase as companies see strong return on capital
  • The impending and still unknown impact of Brexit on companies’ operations and bottom lines is still an area of concern. Many companies are holding back cash in reserve to hedge against any impact rather than get caught short having to borrow in a rising interest rate environment or repatriate cash back from the U.S. at additional cost
  • Many companies have taken advantage of offering early payment of invoices to their cash-strapped suppliers in return for a discount as an alternative investment option. The interesting angle with this is that the accounting impact is directly on the gross margin and EBITDA, and therefore has the potential to have a great impact on ratios than a tax reduction. Additionally, it has the benefit of directly helping the SME base something which is still being hotly debated in the case of Trump’s tax cut

The revamp should also assist efforts towards a concerted international initiative against tax evasion, by persuading many American multinationals to repatriate U.S. business profits that are currently squirreled away in offshore tax havens.

Analysts at JP Morgan expect Europe’s automakers to benefit from the tax cuts along with their U.S. peers, with their earnings per share (EPS) given a four percent boost in 2018.

However, the warning in the finance ministers’ letter reflects fears that the Trump tax cuts could slow Europe’s economic recovery, which is only now picking up momentum nearly a decade after the global financial crisis. According to reports, as much as $2.5 trillion is parked in European accounts by U.S. corporations; a figure that could shrink dramatically if repatriated capital starts returning homewards.

The cuts also come at a time when the European Central Bank, having belatedly followed the Federal Reserve’s lead in 2015 by launching its own quantitative easing (QE) programme, has recently been signalling that it’s ready to start easing off the gas pedal and wind down its €60bn a month bond-buying programme.

It’s not only Europe that is alarmed. Chinese officials are also expressing concern that the Trump tax cuts are bad news for local manufacturers and technology innovation. The new year began with Australia’s business leaders calling on the government to respond with similar moves to maintain the country as an attractive location for investors.

Trump’s optimism isn’t shared by U.S. tax academics, either, who in a recent analysis claimed that a couple of the amendments “likely violate WTO obligations and presents tax treaty concerns”. Former U.S. Treasury secretary Jacob Lew views the legislation as “a ticking time bomb in terms of debt”.

As the New York Times commented: “the new rate… takes the U.S. from the top of the global tax spectrum to the lower end. Countries like Australia, France, Germany, and Japan, all of which have effective corporate tax rates of at least 30 percent, will be under pressure to follow.”

However, ageing populations and adverse demographics in many countries mean the Trump initiative isn’t easily emulated without pushing up government debt. In Germany, where Chancellor Angela Merkel’s efforts to devise a coalition make the prospect of approval for any corporate tax cuts in the near term unlikely. A recent report from the University of Mannheim, entitled ‘Germany loses out in U.S. tax reform’ sees Europe’s biggest economic powerhouse as the main loser as the Trump cuts shift investment and jobs from Europe to the U.S.