The world's largest economy and preeminent superpower, the United States, has this month seen the Senate and the House of Representatives vote through the implementation of major tax reform. Not only will this result have a profound impact on the domestic economy of the U.S., but it also looks inevitable that effects will spread to the rest of the world as well. In combination with the continuation of contractionary monetary policy by the Federal Reserve (Fed), the spillover effect generated by the changes to U.S. macroeconomic policy could be even greater.

Trump is a president renowned for his emphasis on reconstruction in the domestic sectors of the real economy, and tax reform is of central importance to the concept of "Trumponomics." The logic behind the changes is to alleviate the burden on the middle class and corporations through tax reduction, and enhance people's motivation and capability to work, start companies and expand their businesses, thus strengthening the vitality of the national economy. Theoretically it is indeed viable, and its implications extend beyond merely the economy, possessing social significance as well.

Influence at home

The traditional middle class, accounting for around 60 percent of the U.S. population, has been the biggest loser in the wave of globalization that has swept across the world in the last couple of decades. Consequently, subversive forces are building within U.S. society and disillusionment poses a threat to the overall social stability of the country. Tax reduction is conducive to improving the adverse circumstances that are confronting the middle class. Just as the timely release of a compression relief valve dissipates growing pressure, tax reduction serves as a mechanism to enhance both the economic and social stability of the U.S.

It would be incorrect, as some indeed have, to suggest that the top 20 percent of the U.S. population in terms of income, especially the mega rich, are set to benefit from Trump's tax reduction, as this demographic is already well versed in the various ways to evade taxes and other financial obligations in their home country. It is therefore likely that neither the increase nor the reduction of the tax rate would resemble anything more than a token impact on their finances.

Taxes are not a burden to the lower 20 percent of earners within the population either because they have access to comparatively more government support and social aid than those elsewhere on the income ladder. Under a social welfare system heavily influenced by liberal principles, the actual income of those who are out of work and rely on unemployment relief can even exceed that of the traditional middle class, who contribute in terms of both labor and taxes.

By comparison, the traditional middle class is neither able to tap into the benefits of globalization, nor escape from the tax burden imposed by their home country. To make matters worse, they are the net contributors to the country's social welfare system, bearing the majority of the tax burden while receiving relatively meagre support and social aid in return. The middle class has been able to overlook these injustices when the economy is booming and individual livelihoods are good. However, when times of economic recession come around, this inequality has the capacity to swell and intensify. In light of this, tax reform, together with the subsequent reform of the social welfare system planned by Trump, looks set to reverse this economic climate of unfairness and a decreasing enthusiasm for labor.

Tax reduction has a particularly significant role to play in the protection and encouragement of entrepreneurship in the U.S., as it is one of the most valuable characteristics of the American people. Since the end of the subprime crisis, the amount of small and micro manufacturing businesses without employees has skyrocketed, playing an indispensable role in the recovery of the U.S. economy. However, a decrease in the number of employees in the manufacturing industry over the decade is the dark reality of a more conspicuous trend of growth in small and micro manufacturing businesses.

There is no doubt that the marked increase in the number of small and micro manufacturing businesses without employees is a consequence of advances in manufacturing and information technology. Such technological progress lowers the cost barrier to manufacturing, therefore enabling those businesses to access the sales market, having been unable to enter the market prior to the 1990s.

However, the most critical factor in the boom is the fundamental spirit of endeavor and entrepreneurship of the American people. In the aftermath of the financial crisis, the U.S. economy has seen numerous cases of individuals taking their economic future into their own hands instead of waiting for opportunity to come their way. In contrast to Europe, the unemployment rate, more than twice that of the U.S., is persistently high, the individual agency of the U.S. people is to be acclaimed.

Admittedly, the products of their small-scale manufacturers are usually food, manually brewed beer, cosmetics and amongst others, but the unrefined nature of their industries shouldn't be perceived as taking away from their success. It is inevitable that in the future, there will be Fortune Global 500 Companies emerging from this group of manufacturers, such is the entrepreneurial drive of the people, the enormous market in the country and the rags to riches miracles scattered throughout U.S. history. Nor should it be debated that tax reduction is indeed beneficial in the long run for these manufacturers and the socioeconomic vitality of the U.S.

From a macroeconomic perspective, the obstinate illness of the U.S. economy is the double deficit, the concurrence of both trade and fiscal deficits. Since the trade deficit is essentially a representation of negative domestic savings in the U.S., a phenomenon which stems from the fiscal deficit and the deficit of the household sector, it is possible to alleviate the double deficit quandary in the long run. This can be achieved by reducing the intervention of external forces and related inputs, reducing tax and reforming the welfare system, thus incentivizing labor as well as reducing wasteful expenditure.

Spillover effect

As for the international influence of Trump's tax reform, the main outcomes are that the "double play" of U.S. monetary policy and fiscal policy will likely trigger a large scale rerouting of international capital, and thus threaten the stability of financial markets in multiple countries as well as the global macro economy. Tax reform may also make the redirection of the manufacturing industry to the U.S. more attractive, and in doing so, negatively impact a number of emerging markets as well as Europe.

According to the minutes of the most recent Fed meeting released on November 22, the majority of attendants acknowledged the proposal of increasing the benchmark interest rate in the near future. In other words, it is highly likely that the Fed will raise interest rates in order to further tighten monetary policy. Furthermore, the Fed is gathering momentum to shrink its balance sheet, whilst Congress has already adopted a new tax reform. Consequently, emerging markets are faced with the intensified pressure of capital flight, driven by the "double play" of monetary policies, increasing interest rates and a shrinking balance sheet, as well as fiscal and tax policies.

In the international community, U.S. tax reform has attracted widespread condemnation. Opponents of the plan abound in Europe and several emerging market economies primarily concerned that the effect of tax reduction and contractionary monetary policy in the U.S. will cause a large scale reflow of capital and the manufacturing industry to the U.S., thus negatively impacting the local economy.

Another area of concern is that large tax reduction may trigger fiscal dumping competition in various countries, making conditions more severe for nations with poor financial resources as a result of a massive escalation in competition. It is fair to say that the concerns of countries opposed to U.S. tax reform are based on certain objective facts, and some are justified in terms of both economic logic and moral principles.

Among Chinese observers who condemn Trump's tax reform, most can also justify their concerns over negative consequences with a certain level of objective reality. However, they greatly underestimate the resilience and capability of China's economy.

Other concerns in China arise not from the possibility of a direct impact on the domestic economy, but rather from the impact suffered by China's trading partners. After all, exports are of great importance to China in its role as the world's largest exporter. Emerging markets account for approximately half of China's export value, but a number of those countries lack economic and political stability. If they are unable to manage the effects of "double play" in U.S. monetary and fiscal policy, then any corresponding economic crisis could seriously affect China's exports to them.

It is still too soon to say whether the adjustments to U.S. macroeconomic policy will engender negative consequences for China. Whilst it is bound to experience some pressure, depending on how China uses its leverage, the adjustments provide opportunities for advancing domestic tax reform at home and expanding its overseas market.

The author is an op-ed contributor to Beijing Review and a researcher with the Chinese Academy of International Trade and Economic Cooperation

Copyedited by Laurence Coulton

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