Will US tax changes boost economic growth?
03 January 2018 | Markets and Economy
Equities did well in the United States in 2017, not least on the prospect that a rewrite of the US tax code could encourage investment, raise disposable incomes and strengthen economic performance. Now that the much-debated tax overhaul has been signed into law, it remains to be seen whether reality will match expectations.
The legislation generally lowers federal tax rates for corporations and individuals, though its effects will depend on individual circumstances, as it revised many of the rules regarding deductions and exemptions. Most of the government's existing incentives for saving and investing for retirement, education and other goals have been retained.
"The tax law contains wide-ranging changes that will affect investors of all kinds, from individuals and participants to advisers and large institutions," said Vanguard Chairman Bill McNabb. "Naturally, we'll continue to examine all of the provisions to determine the best ways to help our clients meet their goals."
A big break for businesses
The tax law slashes federal taxes on corporations from the current top rate of 35% to a flat rate of 21%. According to the Tax Foundation, a conservative-leaning think tank based in Washington DC, the top statutory corporate tax rate will be 26.5% when state and local taxes are included, putting the US slightly below the 26.9% average for countries in the European Union.
Other business-friendly provisions include the elimination of tax on profits made outside the US. Previously, US corporations were subject to a 35% rate on overseas profits, minus taxes paid in the countries where those profits were earned. Opponents say this new "territorial" approach will encourage US companies to shift operations and investments to countries with lower tax rates, such as Ireland, while supporters say it will do the opposite, boosting exports and making the US more competitive globally.
Lower rates for individuals ... with caveats
For individuals, the US has a graduated income tax structure with seven brackets and numerous exemptions and deductions. The new law introduces many changes.
American ratepayers begin with a "standard deduction" in which a certain amount of income is shielded from federal tax – $6,300 (about £4,700) for an individual and $12,600 (about £9,500) for a married couple. From that point upwards, income is taxed progressively at rates ranging from 10% on the next $9,325 of an individual's income (about £7,000) to 39.6% on anything above $418,400 (about £313,000).
The new law nearly doubles the standard deductions, placing more income out of the government's reach. It retains seven income tax brackets but reduces rates and adjusts the income bands, with the top rate reduced to 37% on income above $500,000 (about £374,000). Significantly, it reduces or eliminates several types of deductions and exemptions, which is likely to diminish the tax advantages for some ratepayers. Critics warn it may also discourage charitable giving, as many Americans will no longer benefit from itemising each charitable gift in exchange for a tax write-off, as in the past.
For US investors, the legislation maintains the existing preferential tax rates for long-term capital gains but redefines the income levels for those rates. Workers will still be able to set aside money for retirement in tax-advantaged investment accounts (similar to the ISA familiar to UK investors) with relatively minor changes.
"While the bill included several features that may require investors to evaluate their tax situation, we are pleased that the final act preserves many of the incentives to save and invest," said Maria Bruno, a Vanguard senior investment strategist based at our headquarters in Malvern, Pennsylvania.
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