Fund managers are becoming increasingly alarmed at the Trump administration’s plans to introduce a radical ‘border adjustment tax’ (BAT) as a way to fund its tax-cutting agenda.
The BAT would impose a 20% tax on revenues from imports into the US while removing tax on exports. As such it sits firmly in president Trump’s ‘America First’ approach, although in fact it is a policy promoted by fellow Republican Paul Ryan.
Ryan, the influential House of Representatives Speaker, sees BAT as a way of closing the funding gap caused by the Republicans’ desire to cut and simplify the US’s expensive and complex corporate tax code.
The other fund-raising measure, that has grabbed investors’ attention far more since the election in November, is the possibility of cutting tax on $2.5 trillion of corporate profits stockpiled abroad, which if repatriated could electrify the US economy.
'Unintended consequences'
But Simon Laing, head of US equities at Invesco Perpetual, fears BAT is a ‘potentially devastating policy mistake’, warning that the ‘unintended consequences are massive’, particularly for food and clothing retailers whose profits could be wiped out by BAT even if corporation tax is slashed from 35% to 15%.
Laing, manager of the Invesco Perpetual US Equity fund, said: ‘These businesses can’t simply source clothes – or olive oil – from the US. The US has nowhere near enough capacity to supply these companies.
‘BAT would decimate the retail sector and any import business. That in turn would lead to massive job losses and probably push prices higher on key consumer goods, neither of which would have the desired effect of accelerating economic growth,’ he said.
Petrol prices would also rise as regardless of the success of the nascent domestic shale oil industry, the US remains a net importer of gasoline, Laing pointed out.
‘The impact would be awful and widespread,’ he said and would not be offset by the huge boost to exporting companies as ‘unfortunately, the US just doesn’t export that much nowadays.’
Dollar debate
According to economic theory the border tax reforms would be offset by an instant 20% rise in the US dollar. This would mean Americans paid higher prices for imported goods on the one hand but on the other their money would be go further.
The dollar would strengthen because of an anticipated increase in overseas consumers buying more US goods as their price fell. Also a fall in US consumer demand for imports would reduce the availability of dollars to foreign suppliers, with their scarcity also increasing upward pressure on the currency.
However, this theory overlooks the fact that most US imports come from countries with currencies pegged to the US dollar, so there would be no offsetting effect from a strengthening currency, Laing argued.
Didier Borowski, analyst at French fund management giant Amundi, agreed that changes to the dollar supply/demand balance caused by BAT would normally be expected to see the greenback jump in value.
‘For a 20% tax at the border – the amount proposed by the House of Representative – the dollar would appreciate 25%, leaving the price relatively unchanged. However, this market mechanism is not automatic. An appreciation of this magnitude is highly unlikely,’ Borowski cautioned.
Nevertheless, any rise in the dollar would still have big implications for the US and global economy, Borowski said. He pointed to Federal Reserve analysis that showed a 10% rise in the dollar was equivalent to a 1% rise in US interest rates, which could slow economic growth.
Protectionist policy
Rathbones asset allocation strategist Ed Smith said BAT was ‘protectionism by another name’.
‘You don’t get to deduct imports from your profit and loss for tax purposes, or to put it another way an export becomes a tax credit,’ he said.
‘This has profound implications for post-tax earnings per share at the company level.’
He added that the complex reform would ‘not make it through Congress in year one’ but questioned whether investors were right ‘to be so bullish on fiscal stimulus from day one and so sanguine about the threat of trade war’.
Schroder US fund manager Matthew Ward did not expect any major changes until ‘the third quarter of 2017 at the earliest’.
He believed Trump’s protectionist approach to trade and taxes ‘could prove most disruptive to growth’.
‘While his latest commentary on border tax seemed more measure and considered, given high odds of trade retaliation and already slowing global trade, this needs to be monitored closely,’ he added.
Uncharted territory
Investors are watching and waiting, hoping that Republicans will avoid a potential policy disaster that could hurt them in next year’s mid-term congressional elections.
‘This president is taking uncharted paths in policy; so unfortunately we cannot write BAT off,’ said Laing.
‘This is a complicated issue that could cause us to change our views on the US economy and market rapidly. And while we own companies who would be materially impacted by BAT, if it does not happen, we would view these stocks as being massively undervalued,’ he concluded.