Will Trump’s tax cuts fix the US middle-income squeeze?

Former US President Donald Trump’s impending return to the White House has created a sense of familiarity and heightened volatility for the global financial markets.

Trump is set to return as the 47th US president on 20 January 2025. His campaign promises are a repeat of his policies from his previous term: tax cuts for individuals and businesses accompanied by even higher tariffs on Chinese imports. The goal, he says, is to spur greater domestic demand, jumpstart American companies, and boost overall economic growth. However, this is easier said than done as foregone revenues from tax cuts could prove costly for the world’s largest economy, especially at a time of a wider fiscal deficit and ballooning federal debt.

More tax cuts

High on Trump’s agenda is the extension of the Tax Cuts & Jobs Act, a measure that he signed into law in 2018 that reduced tax rates for individual earners who fall under higher income brackets. The law also trimmed the corporate tax rate to 21 per cent from 35 per cent. This time, the President-elect said he wants to bring business taxes even lower at 15 per cent for companies that produce their goods onshore, which is opposite of the Biden administration’s plan to raise corporate taxes to 28 per cent to increase public revenue collections.

With the Republicans dominating both the House of Representatives and Senate, passing new tax legislation will likely be a breeze. However, we are of the view that neither Trump nor his competitor, Vice President Kamala Harris, had any major economic reforms laid out that would spark any major shifts in the US economy.

Trump plans to offset foregone taxes with even higher duties to be collected from importers, particularly those bringing in goods from China. He is set to broaden the tariff war which he started with the Mainland in 2018 on top of the 100 per cent tariff which President Joe Biden is charging on Chinese electric vehicles being sold in the US.

Trump said he will introduce a tariff worth up to 60 per cent the value of all China-made products – even though China remains its largest trading partner, as seen in Graph 1.

The incoming president also plans to slap an additional tariff worth 10-20 per cent on all other imported goods in a classic case of trade protectionism. While this may prove beneficial to US-based manufacturers, this would likely result in higher prices of goods, and this does not bode well for the domestic and global economy in the long run. Higher inflation would require future rate hikes from the Federal Reserve, resulting in higher borrowing costs and costlier repayment of public debt.

The US is only seeing monthly inflation readings return to its 2 per cent target after more than three years of rapid price increases that peaked at 9.1 per cent in June 2022, as seen in Graph 2, but has picked up for two straight months to November. This has diminished the purchasing power of middle-income households as the cost of living is outpacing wage growth, leading to a disgruntled middle class.

Lower tax rates would initially increase the disposable incomes of American consumers, but a wider fiscal deficit would create bigger problems in the long term. For one, Fitch Ratings has flagged the US’ piling debt, which is likely to balloon further unless the tax cuts are accompanied by government spending reductions and new revenue streams, as a critical factor that could lead to another credit rating downgrade.

Winners and losers

The recent US elections generated higher volatility in the financial markets for the months ahead despite an initial stock market rally seen the day after voting.

Various industries responded differently to Trump’s victory. Banking stocks soared in the election aftermath as they expect to benefit from relaxed regulations and lower credit costs, while shares of companies closely tied to Trump and his allies also rose like Trump Media & Technology Group Corp. and Elon Musk’s Tesla. In the same vein, US manufacturers saw share prices improve as the expected beneficiaries of Trump’s inward-looking trade policies. Technology stocks climbed as well, buoyed by strong third-quarter earnings reports.

Meanwhile, share prices of real estate companies, utility firms, renewables, and corporations with substantial exposure to Chinese suppliers slid as market players see them as the losers under a Trump presidency.

Heightened market uncertainty has triggered shifts in the fixed income market. Rates fetched by 10-year US Treasuries picked up by 15 basis points on 6 November to a four-month high and has remained elevated in succeeding days, signalling increased cautiousness about the US economy’s trajectory. This diverged from the downward adjustment in key interest rates with the Fed’s fresh rate cut on 7 November.

Investors are largely worried about how Trump’s policies would likely leave America with an even larger fiscal gap, with federal debt beyond 120 per cent of GDP as of end-September 2024. The weight of the tax cuts is unlikely to be offset by increased import duties, and this is the biggest source of worry.

In sum, we see that long-term interest rates in the US will not come down as much and as fast as initially expected in the context of the Trump win. Policy changes in the US merit close monitoring, although we continue to be overweight on US stocks as firms deliver strong profits and with signs that the economy is on solid footing, evidenced by easing inflation and a lower unemployment rate.

This original article has been produced in-house for Lundgreen’s Investor Insights by on-the-ground contributors of the region. The insight provided is informed with accurate data from reliable sources and has gone through various processes to ensure that the information upholds the integrity and values of the Lundgreen’s brand.