US Dollar Rises Marginally After Release of First Draft of Republican Tax Reform

The Dollar rose marginally on Thursday after Republicans unveiled their tax reform plan, however, the increase was well below that which had been anticipated.

EUR/USD fell from the 1.1680s to the 1.1660s after the announcement, but Dollar-gains (equivalent EUR/USD losses) were limited due to widespread skepticism that the bill would get passed.

The expectations had been that the tax reforms would stimulate the economy by leaving more money in tax-payers pockets, allowing businesses to keep more of their profits which they could then reinvest and encourage the repatriation of offshore earnings by companies hitherto practicing de facto tax evasion.

It was thought this would lead to more spending by individuals and businesses and a backflow of earnings back into the US from offshore accounts.

The higher spending would benefit growth, lead to higher inflation, higher interest rates and from there a stronger Dollar because the Dollar tracks interest rates, which when high attract more foreign capital in search of higher returns.

The repatriation of offshore earnings would also push up the Dollar simply due to an increase in direct demand because most of the money is not already denominated in Dollars.

According to the blueprint, the proposed tax reforms would lower corporation tax from 35% to 20% and take it below the global average of 22.5%.

Yet far from setting the Dollar on fire as many had expected the publication of the tax reform plan left the currency strangely unmoved.

This might have been because there was little new material contained within the blueprint, or perhaps because the proposals were deemed unlikely to get the support required to pass them into law. 

"The idea of this plan getting approval is a longshot," commented Phil Blancato, CEO of Landenberg Thalman Asset Management in New York, as quoted on Investing.com. 

"I don't think the market or most economists think they can get this done. There is just not enough consensus in the house to move this forward," he added.

Indeed, it is a bleak prospect for the tax reformers that it has been over 30 years since any administration has been able to get tax reforms approved by Congress, the last time being under Ronald Regan in 1986.

Its Not Taxing Offshore

The draft bill contained proposals for encouraging the repatriation of hundreds of billions of untaxed earnings stashed offshore by US companies or their subsidiaries.

It is this policy as much as the cut in corporation tax which would be expected to lead to a rally in the Dollar. 

It was recently estimated by Bank of America Merril Lynch that over half of offshore money is not in Dollars and so would have to be exchanged if repatriate, creating a surge in demand for the Dollar and leading to a substantial appreciation in value - as happened in 2004 during the Homeland repatriation Act.

"The framework transforms our existing “offshoring” model to an American model. It ends the perverse incentive to keep foreign profits offshore by exempting them when they are repatriated to the United States. It will replace the existing, outdated worldwide tax system with a 100%  exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake)," says the tax reform blueprint.

The lack of response from the Dollar may be because the Tax reform framework guidelines could have disappointed those hoping for an outright moratorium or tax-free holiday, as it still appears companies repatriating money may still be liable for some tax albeit at a lower rate and spread out over a longer period.

"Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years," said the draft bill. 

Other details in the proposal were already largely common knowledge such as the proposal to simplify the number of tax bands to only four: 12, 25, 35 and 39.5% for very high earners. 

The proposal to repeal the death tax and the transfer tax - both forms of inheritance tax - had also already been widely telegraphed.

A form of married couple allowance was introduced which allows a couple to bundle their individual 12k tax-free allowances together.

The bill lowered taxes for small businesses by making the highest rate small companies and sole traders could only 25% and by allowing more depreciable assets to be written off as business expenses

The changes proposed, included a rise in child tax credits to help middle-class families.

The proposed bill would eliminate a  popular mortgage interest deduction for new home loans of $500,000 or more.

Though business credits would be phased out they would be retained for R&D and low-income housing.