Japan Institute for National Fundamentals

　　　　　The U.S. tax reform, the biggest in about 30 years, committed by President Donald Trump is expected to pass the Senate and the House of Representatives this week. The reform will reduce the attention-attracting corporate tax rate from 35% to 21% in 2018, bringing a record $1.5 trillion in overall tax cuts over the next 10 years. Financial resources for the tax cuts are envisioned to be covered by future revenue increase to be gained with economic growth acceleration resulting from the tax cuts.

Tax cuts cannot accelerate economic growth
　　　　　The tax reform bill proposed by the Republican Party, with a focus on massive corporate tax cuts, is primarily designed for demand expansion through the tax cuts, as indicated by President Trump’s statement that the tax reform would be “a big Christmas present.” Generally speaking, tax cuts are expected to boost economic growth over a short term by increasing disposable income to stimulate consumer spending and corporate investment in plant and equipment. However, a tax reform to expand supply rather than demand is more important. Such reform is expected to accelerate productivity improvement and capital stock growth to raise growth potential. Required for raising U.S. growth potential is the tax reform to expand supply.
　　　　　While President Trump expects that the tax cuts would accelerate U.S. economic growth to more than 4%, Federal Reserve Chairwoman Janet Yellen refrains from sharing the expectation with Trump. The Fed’s Federal Open Market Committee has left a projected long-term U.S. economic growth rate unchanged at 1.8%. Massive tax cuts and fiscal spending expansion, though pushing up the GDP growth rate over a short term, may fail to increase growth potential, with any economic pickup ending up short-lived. We must prepare for a harsh reaction to a possible failure of expectations placed on the Trump policy.

Big impact of dollar reflux
　　　　　The massive corporate tax cut is likely to encourage U.S. and foreign companies to expand investment in the United States, stimulating the U.S. economy. The Fed may be prompted to raise interest rates, leading to a dollar reflux into the United States.
　　　　　European countries getting on a recovery path cannot afford to further cut their tax to counter the U.S. policy because of their huge debt.
　　　　　Learning from lessons from massive capital outflow from 2015 to 2016, China has toughened capital regulations. As the U.S. tax reform leads to greater inflation and interest rate hikes to induce a dollar reflux into the United States over a long term, however, it may be difficult for China alone to take advantage of its monetary policy for preventing a decline in investment from abroad. Rather, the dollar reflux could accelerate U.S. companies’ reshoring home.
　　　　　The latest U.S. reform will lead the U.S. corporate tax rate to slip below South Korea’s maximum tax rate, while U.S. interest rates is expected to rise above South Korean rates. Such reversal will have no small impact on South Korea. Other emerging or developing countries will be exposed to immeasurable effects of the dollar reflux into the United States.
　　　　　As for Japan, improving productivity to enhance business competitiveness without joining a race to cut corporate tax is an urgent issue.

Yujiro Oiwa is a JINF Planning Committee Member and Professor at Tokyo International University.

(Editor's note: The US drastic tax cut bill was passed through both houses on December 20.)