IMF warning on Trump tax plan risks

President Trump’s plans for US tax reforms and a relaxation of some financial regulations risks destabilising corporate spending and could result in a return of the excessive financial risk taking seen in the run up to the 2008 crisis, according to the International Monetary Fund (IMF)

The IMF’s latest Global Stability Report, published twice each year, warns that in the US   ‘policymakers should provide incentives for economic risk taking while guarding against excessive financial risk taking.’

In a section entitled ‘Is the US Corporate Sector Ready to Accelerate Expansion—Safely?’, the IMG singles out Trump’s tax policy reforms, in particular, as harbouring the potential to encourage economic risk taking—in the form of corporate capital spending—in two key ways.

Firstly, a cut in the statutory tax rate for corporations would directly boost corporate internal funds. The IMF says the cash flow boost from such a tax cut could be amplified by policies to encourage the repatriation of foreign earnings. Secondly, Trump’s aim of eliminating interest deductibility of debt and immediate expensing capital expenditure could reduce the debt bias inherent in corporate financing decisions, putting equity finance on a more equal footing with debt financing.

The report estimates that a cut to the statutory tax rate could provide a considerable cash flow impetus to Standard & Poor’s (S&P) 500 firms, amounting to more than $100bn (£78bn) a year, on top of existing cash flow of more than $1 trillion. These tax-related windfalls could cover higher capital spending in seven of the ten main S&P 500 nonfinancial sectors.

The combined effect of expensing investment and the removal of interest deductibility would further increase cash flow in capital-intensive sectors—such as energy, real estate, and utilities. Repatriating liquid assets held abroad by US companies would also benefit the information technology and health care sectors, where 60% of the $2.2 trillion in unremitted foreign earnings held abroad is concentrated.

The IMF highlights concerns that cash flow from tax reforms may accrue mainly to sectors that have historically engaged in substantial financial risk taking, and say ‘such risk taking is associated with intermittent large destabilizing swings in the financial system over the past few decades’.

The report also flags worries about increased leverage in US companies, and the proportion of income devoted to debt servicing. It says an unproductive fiscal expansion could lead to a sharp rise in borrowing costs, and warns that an increase in interest rates amid tepid earnings growth could further compromise the ability of firms to service their debt.

The report states: ‘Under this scenario, the combined assets of challenged firms could reach almost $4 trillion. The number of firms with very low interest coverage ratios—a common signal of distress—is already high.

‘The stark rise in the number of challenged firms has been mostly concentrated in the energy sector, partly as a result of oil price volatility over the past few years. But the proportion of challenged firms has broadened across such other industries as real estate and utilities. Together, these three industries currently account for about half of firms struggling to meet debt service obligations and higher borrowing costs.

The IMF says that in order to mitigate the financial stability risks, ‘regulators should pre-emptively address any areas in which risk taking appears excessive’, and says additional financial prudential and supervisory action may be required.

IMF Global Financial Stability Report April 2017 is here.

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