Economic Update: 6 October 2017
The Investment Management team round-up some of this week’s news.
The rise of the independence movement in Catalonia, one of the most populous and prosperous regions in Spain, is creating divisions across the country. The vote for independence has been rejected and declared illegal by the Spanish government, and the European Union has also refused to accept the region’s referendum result.
The current situation originates from a point in history, when in 1640 through to 1652 Portuguese and Catalans rose in rebellion against Spain. However, it was only the Portuguese that successfully gained independence.
Catalonia is one of the biggest contributors to Spain’s economy: people living in the region make up 16% of the total population and account for 20% of economic output making it the most valuable contributor to Spain’ gross domestic product. Spain has a high level of indebtedness of over 1.1 trillion euros and Catalonia makes a substantial contribution towards repayments.
The current economic growth forecast for this year, released by the Bank of Spain stands at 3.1% and without a resolution, confidence could weaken and perhaps restrain consumer spending.
Equity and bond investors have experienced some mild effects. In 3 days after the independence vote on Sunday, equity prices reacted by falling 4.01%. Bond yields also rose from 1.60% to 1.77%, but despite the political tensions yields remain at very low levels. As tensions are easing, equities rose 2.51% and bond yields dropped to 1.69% on Thursday.
The general sense is that it is still too early to forecast how events will unfold but the hope is that negotiations will produce some form of acceptable compromise.
Spanish Equity and Bond Markets
Source: Bloomberg, data as of 04/10/2017
Trump’s Tax Cut Plans
Tax reform was one of Donald Trump’s key initiatives when campaigning to be the next president of the US. After an eventful 9 months in office, tax reform has now come to the forefront of the Trump administration agenda.
The recent preliminary tax plan reform reiterates Tump’s promise that tax cuts will benefit “the middle class, the working men and women, not the highest-income earners”. The plan promises a near-doubling of the amount that can be earned before paying income tax. For an individual, it would rise annually to $12,000 from $6,350 today. This is less generous than it sounds because the personal exemption, currently set at $4,050, which performs a similar function, will be abolished.
If enacted, the tax plan will also raise the bottom rate of income tax from 10% to 12%. By contrast, the top rate of tax, is expected to fall from 39.6% to 35%. Trump says Congress is free to create a new top tax rate for the super-rich, but few Republicans will be keen to take up that option. The plan would slim the number of tax brackets to three, charged at 12%, 25%, or a 35% rate.
While Tump has argued this is set to benefit the middle and working class people, the planned abolition of the estate (inheritance) tax will only benefit those with assets worth $5.5m or more.
Corporation tax has been proposed to be cut from 35% to 20%. Mr Trump argues that the benefits of a low corporate tax would flow primarily to workers, in the form of higher wages. A plan to create a new 25% tax rate that is proposed for business owners who include their firm’s profit on their personal tax returns would greatly benefit many higher earners.
There are other detailed aspects but as it stands the proposals in aggregate will increase government borrowing substantially, but Republicans believe tax cuts will trigger much faster economic growth, thereby plugging any hole.
How highly taxed is the US? – Total tax as a % of the economy (Gross Domestic Product)
Source: Organisation for Economic Co-operation and Development (OECD)