What's going on here?
The US Senate passed a bill over the weekend containing huge changes to the US tax system – and stocks have been celebrating.
What does this mean?
Before becoming law, the bill must be reconciled with a similar bill that has already been passed by the US House of Representatives. While the passage of a final bill is still not a slam dunk, passage by the Senate is a big move in that direction.
Both bills cut taxes on companies to 20% from the current level of 35% – a tidy discount! They would also lower the tax rate on money US companies move back home from overseas. There are also a bunch of proposed changes to individuals’ taxes (read more here).
Why should I care?
The bigger picture: The reforms aim to improve an American tax quirk.
One of the curious aspects of the current US tax system is that it encourages US companies with international operations to keep their overseas profits in other countries: those profits are taxed at the relatively high US tax rate if they’re brought into the US. While companies won’t necessarily spend the money they bring home on economically productive things – like building new R&D centers – it’s (arguably) better for the US economy if companies bring money back rather than leave it elsewhere (where it has zero chance of directly benefiting the US economy).
For markets: Stocks like tax cuts!
US stocks, especially those of companies that do most of their business within the US, moved significantly higher last week as it looked more likely that the bill would pass in the Senate. Unsurprisingly, investors like lower corporate taxes because they tend to boost profits. It’s less obvious whether there will be a big impact in foreign exchange markets if the bill becomes law – companies may, for example, sell currencies like the euro and buy the dollar if they plan to move money back into the US.