Donald Trump has big win on tax plan

Step by step, American markets are becoming more confident that Donald Trump will deliver his tax cuts.

Tax policy is at the core of Donald Trump’s planned revolution. Pic: AFP

Step by step, the American markets are becoming more confident that President Donald Trump will deliver his tax cuts.

This policy is at the core of Trump’s planned revolution and because that revolution will totally transform world interest rate and currency markets, Australians must keep fully abreast with what is happening.

And the most reliable indicator of market sentiment is not the US share market but rather the 10-year US bond rate.

In the weeks that followed the Trump inauguration, US 10-year bonds were sold down because the market believed the massive stimulation he proposed would lift interest rates. The 10-year rate rose to 2.6 per cent in March.

But in the next six months the Russian affair and all the other Trump problems saw the market totally disillusioned and bond prices rose more than 25 per cent and the yield bottomed at 2.06 per cent early in September.

But by then President Trump had started to get his act together and reorganised his administration and the bond rate began to rise.

Along with others I alerted Australians to the fundamental change in the Trump administration and tactics. And during September there was more progress.

Over the weekend the 10-year bond rate soared to 2.38 per cent---- well on the way back to the 2.6 per cent of rate of last March.

In the coming weeks there will be fluctuations up and down as the US 10-year bond market becomes the proxy for the debate. But it’s also important to underline that the US share market has found a way to win both ways. When confidence about the US tax package success declines and bond interest rates fall, shares benefit from the falling interest rates.

When tax success looks more likely shares rise again because of the looming explosion of growth and inflation. This is why Wall Street is hitting new records.

In Australia, US tax cuts will trigger debate about corporate taxation rates and while that is important it will not get far in the short term given the state of the parliament and the complexities with dividend franking.

But if a major portion of the Trump package is successful then global interest rates will rise further and almost certainly so will the US dollar. Australians trading in US dollars

need to be aware to this direct link to the US bond market.

The latest rise in the US bond rates was triggered by the clear indication that Trump’s courting of the Democrats last month had worked. The Republicans combined in the Senate to set up what’s known as the “reconciliation” process, which allows big financial measures to pass the US Senate by majority vote. Democrats used reconciliation to ease passage of Obamacare in 2010, and Republicans used it to pass tax cuts in 2001 and 2003.

The Republicans had been split, but united at the weekend with only one of their number voting against the measure. It was a big win for Trump. One of his supporters, speaker House of Representatives Speaker Paul Ryan, signalled signs of flexibility. Not only did Ryan confirm a fourth tax bracket for high-income earners but indicated that not all the tax measures might pass at once.

“Fights that can’t be won in the next few weeks can be won in this presidential term” he said.

On the total package he said: “This is about the people, about half of which in this country are living pay check to pay check, and giving them a break on their taxes, giving them some tax relief, and closing loopholes and carve-outs, which disproportionately benefit the very high income people.

The goal is “helping the middle class and incentivising businesses to keep their money and jobs in the US”.

Speaker of the House Paul Ryan. Pic: AP

The Trump plan would reduce tax brackets for Middle America from seven to three, with tax rates of 12 per cent, 25 per cent and 35 per cent. The current top rate is 39.6 per cent and the lowest rate is 10 per cent. Almost certainly a fourth higher income bracket above 35 per cent will be inserted.

The corporate tax rate falls from 35 per cent to 20 per cent.

About 95 per cent of businesses in the United States are structured businesses, partnerships and sole proprietorships whose profits “pass through” to their owners. A new tax rate will be created for them at 25 per cent, not the individual rate of their owners that currently applies.

And there will be incentives for American companies to bring back their overseas dollars. If Trump is successful on that front trillions will return to the US, which then gets channelled into infrastructure, further igniting the US boom. Or at least that is the plan.

Under the original Trump plan the tax cuts would be paid for first by the extra revenue created with higher growth; second by tariffs and/or other measures to put a charge on imports and thirdly the reduction in government expenditure led by Obamacare.

That’s why Trump continues to attack Obamacare. Free trade deals and protection will return to the agenda with a vengeance if some form of normality can be restored in Korea.