The Moody’s credit rating agency has exposed the shoddy analysis and boosterism about the latest ‘tax policy/cut’ trumpeted by President Donald Trump last week especially here in Australia from some analysts and the likes of the Business Council, Treasurer Scott Morrison and Malcolm Turnbull.
In its latest credit outlook issued on Monday, Moody’s said that while the “tax reform framework” released last week would be “credit positive for most other sectors” of the US economy it would likely be credit negative for the US Government” which currently has a Aaa rating from Moody’s.
In other words if the tax cuts (the corporate rate cut from 35% to 30%, the ending of many tax deductions, such as for state and local taxes and the closing of loopholes) actually happen, it could see America’s credit rating cut – or at least the current rating put on a negative outlook from its current stable footing.
At a time of the first sign of a cor-ordinated global economic rebound from the GFC and the Fed pushing up interest rates (along with the Canadian central bank and perhaps the Bank of England next week), the importance of credit ratings will start coming back into vogue so far as many investors are concerned.
Unlike many early reports in Australia, Moody’s pointed out that the “The (Trump) framework is light on details and is the first step in congressional negotiations.” In other words a tax cut by the US is not the forgone conclusion that the BCA especially, and some analysts would have us believe.
And Moody’s doesn’t believe in the nonsense that a cut in tax will bring higher growth, higher revenues and a lower budget deficit (which is also the view of Federal Treasurer, the Prime Minister and Treasurer Morrison, as well as the BCA).
"The framework is broadly in line with our assumption that tax cuts would not be offset by equivalent cuts to spending, which would put upward pressure on the federal budget deficit and debt. The tax reform’s effect on economic growth and, in turn, federal government revenue would also affect US credit strength. Given the information that has been released thus far, we do not think that any increase in taxable income from higher growth will compensate for the proposed cuts in tax rates, Moody’s said in Monday’s credit outlook.
In other words the US deficit would rise sharply, as would American debt – which in turn could very well prompt a series of battles in Congress over the debt ceiling that we saw this March-April (and in 2011 when it saw Standard & Poor’s cut America’s credit standing to AA+ from AAA).
"The proposed elimination of the deduction for state and local taxes would be credit negative for the public finance sector by raising the effective cost of state and local taxes for many taxpayers and reducing disposable income. The reform’s effect would be to increase political resistance to tax increases and suppress home values and property tax revenue growth, particularly in high-tax regions.” That is something not even mentioned by many offshore commentaries (especially in media like the Financial Times) or at all in Australian commentary.
Moody’s does see benefits – for example it believes "The framework contains several credit-positive policy elements for the US sovereign, including in particular, efforts to broaden the tax base by eliminating many tax deductions. Generally, a broader tax base creates more predictable and resilient revenue flows and reduces the distortions of economic actors’ behavior that tax code provisions cause. A lower corporate tax rate and full deductibility of capital expenditures in the period spent would benefit corporate credit quality.”
"The proposed territorial tax system, which would no longer require companies to pay taxes on repatriated profits from overseas operations, would benefit corporate credit, depending upon how corporates put monies to use.”
"For banks and insurance companies, a lower corporate tax rate would boost profitability. Although additional profits would not necessarily be used to directly bolster capital, they would provide greater protection to capital in the event of increased credit costs or claims. Additionally, banks currently reduce taxable income by deducting interest on deposits and borrowings. We assume that netting interest expenses against interest revenues will largely remain in place.
"The asset management industry would benefit from a lower tax rate. A repeal of the estate and alternative minimum taxes would make more discretionary assets available for investment in asset management products, which would increase related fees.
But even there Moody’s sees problems … “the loss of interest deductibility would be a burden for speculative-grade companies (which have issued hundreds of billions of dollars in junk bonds for example) because of their debt service expenses. Moody’s points out that the tax changes and eliminating loopholes and changing the write off rules for business investment will not benefit the huge utilities sector where states in particular sell rules on depreciation, deductions and prices, as well as new investment.
And while Moody’s sees tax cuts for companies and individuals being “credit positive across US structured finance markets tied to consumer and commercial assets if it increases the amount of obligors’ income available to service debt”, it also warned that a “partial reduction of corporate interest deductibility would be negative for collateralized loan obligations and commercial and esoteric asset-backed securities backed by speculative-grade obligors if the obligors fail to benefit enough from other changes.”
“Because many of the borrowers of prime jumbo loans underlying residential mortgage-backed securities are in higher tax jurisdictions, eliminating deductions for individual state and local tax payments would be credit negative if it resulted in a net tax increase for enough of these borrowers.”
These securities include securitised car loans, home loans and student debt – the three largest areas of debt for American consumers – and in car and student loans, the two biggest areas of worry from regulators. Many analysts fear that these two areas are the current equivalent of the sub prime mortgages that helped trigger and fuel the GFC. And believe it or not, sub prime home mortgages are making a comeback in the US, including through securitised loans.
