The “trade war” may be last year’s news; a “tax war” may be getting underway this year.
After last year’s U.S. tax cuts contributed to better growth and market performance, a number of major countries are looking to reverse the declines in growth and voter satisfaction with tax cuts in 2019.
Could we see a “race to zero” as countries seek to lower tax rates in order to compete for investment and a larger share of global growth?
The “trade war” may be last year’s news; a “tax war” may be getting underway this year. Competition to lower corporate tax rates around the world this year may help to support slowing global economic and earnings growth, potentially offsetting some of the drag from last year’s trade tensions.
Trade policy and monetary policy are still getting a lot of attention from investors, but fiscal policy may turn out to be a bigger factor for markets in 2019. Monetary policy may start to see less attention from investors, with the Fed likely to pause raising rates sometime this year—if not already—and other major central banks, like the European Central Bank and Bank of Japan, unlikely to make major changes. Instead, attention may turn to fiscal policy. While monetary policy influences the economy using the money supply and interest rates, fiscal policy influences the economy through government spending and tax policies. After the U.S. cut taxes last year, contributing to better growth and market performance, a number of major countries are looking to reverse the declines in growth and voter satisfaction with tax cuts in 2019.
In Europe’s largest economy, Germany, solid growth in recent years has meant the country could run a budget surplus, socking away revenue to be used for a rainy day. That day may have come. Germany’s economy barely skirted recession in the second half of 2018. Chancellor Angela Merkel’s government has been discussing the need for individual and corporate tax cuts and her chosen successor, Annegret Kramp-Karrenbauer, is also calling for tax cuts to support the economy. Germany has a history of cutting taxes when confronted with an economic slowdown after running a budget surplus, as you can see in the chart below.
Time for a tax cut?
Source: Charles Schwab, Bloomberg data as of 1/17/2019.
The Brexit-related economic slowdown in the U.K. has prompted lawmakers to bring forward cuts to income taxes and other changes to taxation, as well as consider lowering the corporate rate to 17% in 2020 from the current 19%. The U.K. already has the lowest corporate tax rate among major countries, as you can see in the chart below.
Falling: corporate tax rates by country
Source: Charles Schwab, KPMG data as of 1/17/2019.
China’s National Statistics Bureau reported that GDP slowed to 6.6% in 2018, the slowest rate of growth since 1990. China, the world’s second-largest economy, has been incrementally announcing new stimulus measures in response to a sharper-than-expected economic slowdown last year. China’s traditional methods of stimulating its economy through infrastructure spending or lower rates/weaker currency have drawbacks, especially with China in the midst of tense trade negotiations with the United States. The details have yet to be announced, but officials said that tax reductions would amount to about 1% of GDP. That would be on top of reductions that have taken China’s government fiscal revenue down to the lowest level since 2009, as you can see in the chart below.
China’s government tax revenue dips to lowest in 10 years
Source: Charles Schwab, Bloomberg data as of 1/21/2019.
There are plenty of other countries with plans for tax changes, as well.
- With an eye on the U.S. tax cuts and Canada’s election later this year, Canadian Prime Minister Trudeau is offering tax breaks to businesses with $10.5 billion in corporate tax cuts planned over six years, instead of reducing the deficit.
- In the Netherlands, Prime Minister Rutte has rolled out plans to cut the corporate tax rate to 21% from 25% and eliminate a 15% tax on dividends.
- In Australia, tax cuts for individuals were passed last year for 2019 in addition to lowering the tax rate on smaller business from 30% to 25%. Corporate tax cuts for larger businesses failed to gain enough support, but that could change.
- An exception to the trend of tax cuts in 2019 may be Japan, where growth estimates have been tempered by Prime Minister Abe’s plan for a sales tax increase later this year. But a further slowdown may see the implementation of the tax increase delayed, which could boost the outlook for growth.
Race to zero
In a challenging environment for growth and investment, countries may embark on a new “race to zero.” When facing weakening economic conditions ten years ago, the so-called race to zero referred to countries aggressively cutting interest rates and competitively devaluing their currencies in an effort to boost domestic economic growth. The new race to zero may take the form of fiscal policy as countries embark on a “tax war” seeking to competitively lower tax rates (although not actually to zero) in order to attract investment and boost growth.
While some countries have little room to implement any more monetary policy stimulus, with policy interest rates still negative in many countries, there may be some room for fiscal policy to aid growth. While the tax cuts announced so far may not be enough to reverse or even stabilize the global slowdown, additional actions may become increasingly important to for investors to watch and more potent at driving market moves.