John Redwood: Will we see “a phenomenal, big league” tax reform in the USA?

President Trump is not one for understatement. He is very bullish about his plans for tax reform. The US stock market so far has liked the general idea of lower taxes, which has been part of the reason shares have done well since the election. Today we will hear a bit more about which detailed plans Trump will adopt when he speaks to both houses of Congress.

In the Presidential election, candidate Trump offered substantial tax cuts on personal taxes. He proposed cutting the 35 per cent rate of Federal Corporation Tax to just 15 per cent. The problem with this scheme is political. The Senate and the House have the powers to approve or block changes to the tax codes. These proposals would be seen by the legislators as lowering the tax take, though the President would probably argue they will trigger faster growth and offset revenues from better economic performance. Any tax package which lowers the revenues needs a super majority in the Senate, which means winning over Democrat votes. In their current mood about Trump it does not look likely that cuts which Democrats would present as helping the rich could possibly attract their votes if they also lower the revenues.

In the House of Representatives a simple majority suffices to change tax law. Speaker Paul Ryan leads the Republican majority and is himself a keen tax reformer. He is currently seeking to persuade the President of the virtues of his alternative corporate tax reform plan. He wants to abolish the present Corporation Tax and replace it with a Border adjustment tax or Destination based cash flow tax instead. This has three big advantages for Trump. The first is the House Leader wants it. The second is it would raise additional revenue, so it would not need a Senate super majority to pass. The third is it hits importers and helps exporters, tackling the trade imbalance and the lack of factories and jobs in the USA directly.

How does this tax work? At the moment if a US corporation exports something to the EU, for example, it pays a 20 per cent VAT on the export and pays 35 per cent corporation tax on the profit it makes on the transaction. If another US corporation imports a good from the EU it pays no VAT on the import, but just pays 35 per cent corporation tax on any profit after treating the cost of the import as an allowable cost. Under the Ryan proposal the corporation tax rate would be cut to 20 per cent. The export to the EU would be free of corporation tax but still pay the EU’s 20 per cent VAT. The import would attract a 20 per cent tax on the full value of the import and on any profit made on that import. Because the US currently imports more than it exports, there would be a revenue gain to the US despite the cut in the corporation tax rate to 20 per cent from 35 per cent. The advocates argue this is fair as it effectively means the US imposing a VAT on imports.

There are however some big-hitting critics of this approach. Some international trading partners think the new system would be unfair on their exports to the USA. They point out the domestically produced good does not pay the 20 per cent tax on its cost of supply in the way the imported good does, whereas the EU’s 20 per cent VAT applies to imports and domestic goods alike. There is talk of taking this issue up with the World Trade Organisation. In the US itself the large retailers are organising to oppose this, as they import a lot of goods and do not like the idea of having to charge more or make less profit on all those imports. Two large lobbies, Americans for Affordable Products and American Made coalition, have formed to slug out the arguments in an effort to win the votes of members of Senate and the House. It would be a gripping debate, with those who want more made in the US at variance with those who simply want the cheapest products for customers.

So is any of this likely? Trump may find he has to do a deal with Speaker Ryan, and find a tax reform that does increase revenues to avoid problems in the Senate. This, however, is not without political trouble in its own right. If the tax plan is budgeted to increase revenue, some true tax cutting Republicans become less enthusiastic and more minded to support the Americans for Affordable Products approach. There are two Republican Senators making the case against the Ryan plan already. Trump will need a majority in the Senate where Republicans only hold 52 out of the 100 seats. All this points to a more protracted and argumentative process than the President would like. Trump is right to want to sweep something through this year while there is still a Republican majority and some Republican goodwill towards him. We will watch carefully to see if a package emerges which can be put through in good time. The Ryan plan or some variant of it would be good for exporters and domestic manufacturers, but negative for retailers and importers.

John Redwood is chief global strategist at Charles Stanley