First it was the Chinese, now it’s the Europeans, as the rest of the world is suddenly very unhappy with the prospect of US tax reform (or maybe it is an unexpectedly strong US economy). As we discussed yesterday, with the historic Trump tax reforms on the verge of passage and the Fed’s dot plot signalling another 7-8 rate hikes (soon to be revised much lower), China is nervous that the capital outflows, which it thought it had bottled up, might be about to return. China is preparing a contingency plan which includes “higher interest rates, tighter capital controls and more-frequent currency intervention to keep money at home and support the yuan”.

Amusingly, the Wall Street Journal quoted a Chinese official who described Washington’s tax plan as a “gray rhino”. The latter is a combination of an “elephant in the room” and a “black swan”, i.e. a high probability threat which people should see coming, but don’t. The focal point of China’s fears is the Yuan, which the authorities have spent so much time and effort stabilising during the last two years. Speaking to the WSJ, the Chinese official sounded a warning: “We’ll likely have some tough battles in the first quarter.”





Switching to Europe and five European finance ministers have sent a letter criticising the US for undermining the “rules of the game” and international trade. Notwithstanding Brexit, the signatories included the UK Chancellor, Philip Hammond, as well as his counterparts in Germany, France, Italy and Spain. Essentially, the European nations are warning the US that it risks starting a trade dispute.

According to the Financial Times, "the finance ministers from Europe’s five largest economies have warned the Trump administration that Republican tax cut plans would flout international agreements and undermine trade, threatening to turn a Washington policy battle into a transatlantic row."

In a letter to the White House and US Treasury department, the ministers - including Philip Hammond of the UK, Peter Altmaier of Germany and Bruno Le Maire of France - raised the possibility of retaliating if the legislation becomes law. The letter highlights concerns in Europe that the Trump administration will use tax reform as a route to promote “America first” trade discrimination, escalating tensions that have already risen in other policy areas like the environment and Middle East peace. The ministers insisted they were not seeking to intervene in a domestic tax debate, which they called one of “the essential pillars of a state’s sovereignty”. Nevertheless, the letter warned Steven Mnuchin, US Treasury secretary, that Washington should not start a trade dispute under the guise of anti-avoidance measures in taxation. “We have strong concerns if (US action to protect its tax base) is done via measures that are not targeted on abusive arrangements as this would impact on genuine business activities,” they wrote.

The letter was sent to Treasury secretary, Steven Mnuchin, White House economic adviser, Gary Cohn and the heads of congressional committees who are currently embroiled in merging the different versions of the tax reforms passed by the Senate and the House of Representatives. From the European perspective, the sources of contention are three measures which favour domestic US businesses, as the FT explains.

All of the measures that have angered European governments would treat US operations differently than those from overseas groups, provisions that the finance ministers said violate international tax norms. For example, an “excise tax” in the House bill would impose a 20 per cent levy on US company purchases from their foreign subsidiaries which would not apply to similar domestic transactions. The letter said this “could discriminate in a manner that would be at odds with international rules embodied” in the World Trade Organization.

The other two elements are the Senate bill, including a provision that would tax US exporters more favourably when they make profits from brands and other intangible assets. The letter argues the measure could “face challenges as an illegal export subsidy”, a thinly-veiled threat of European retaliation. Other Senate measures would tax transfers within international banks and insurance companies on the total amount sent between US and European operations regardless of the balance between transatlantic flows. Some of the European criticisms have been shared by a group of US tax academics, who published a recent analysis that said both the excise tax and financial flows measure “likely violates WTO obligations and presents tax treaty concerns”.

In a swipe at the poor lines of communication between the Trump administration and European nations, a French finance ministry official noted that using “more informal” methods of communication hadn’t worked, consequently, they had resorted to a formal letter as a “way to weigh into the debate”. Germany’s Finance Minister, Peter Altmaier, acknowledged that the US has the right to change its tax regime as it sees fit ”but it must be in compliance with the international rules”.

A spokesperson in Mnuchin’s Treasury department said that “We appreciate the views of the finance ministers.” However, with the tax reform being a centrepiece of Trump’s policy and US lawmakers rushing to finalise the legislation by the end of the year, we see little prospect of major changes to satisfy European concerns at such a late hour.

This latest dispute re-opens the wound of arguments between Europe and the US and over tax, as the FT notes.

”The European letter is only the latest in a series of disputes between Europe and the US over tax issues that date back to the Obama administration. Then-President Barack Obama publicly complained about European Commission actions targeting American tech groups for “sweetheart” tax agreements with several low-tax EU countries. The most high-profile case has come against Apple, which has been ordered by Brussels to pay €13bn in back taxes to Ireland, but the commission has also opened similar cases against Amazon in Luxembourg and Starbucks in the Netherlands.

One difference between the current dispute and previous ones is that this time, the relationship between the incumbent US Administration and major European nations is considerably worse. Even the so-called “special relationship” between the US and UK has been damaged by a spat over Trump re-tweeting anti-Islam video from the deputy leader of a British far-right group.





Meanwhile, both the US and European Union are engaged in a dispute with China about the latter’s status as a market economy within the WTO. Granting it market economy status would make it more difficult for other nations to penalise China with duties. for dumping products, e.g. steel, at unfair prices. As we discussed, there is speculation that a Chinese victory in the dispute with Europe (the US will be settled afterwards) – and a decision is expected in 2019 – could lead to the demise of the WTO.



It’s becoming increasingly clear that the risk that a dispute between the triumvirate of the US, Europe and China escalating is significantly higher now than it has been in recent memory, which in itself should naturally be sufficient to send the S&P to new all time highs this morning.