TheChek News Flow

The proposals would threaten to increase federal debt and interest rates

Just as Ronald Reagan’s landmark 1986 bipartisan tax reform increased simplicity, fairness and economic efficiency by broadening the tax base and reducing rates, today reform of the system has the potential to help American families and the economy.

Properly designed, revenue-neutral reforms could help to offset the dramatic increases in inequality that have taken place over a generation, repair a business tax system that globalisation has rendered dysfunctional, reduce uncertainty and promote growth.

Unfortunately, what we know of the intentions of the president-elect and congressional leadership suggest that they risk pushing through the most misguided set of tax changes in US history.

The proposals from the presidential campaign, reiterated last week by President-elect Donald Trump’s choice for Treasury secretary, will massively favour the top 1 per cent of income earners, threaten an explosive rise in federal debt, complicate the tax code and do little if anything to spur growth.

A core principle agreed to by all in 1986 was that reform would not reduce the tax burden on high-income taxpayers. Reagan achieved this objective while reducing top marginal rates because he raised capital gains rates, scaled back investment incentives, increased corporate tax collection, curtailed shelters and left estate and gift taxes alone. Unfortunately, neither the Trump plan, nor the one put forward by Paul Ryan, speaker of the House of Representatives, provides for nearly enough base-broadening to finance all the high-end tax cutting they include.

Steven Mnuchin, Treasury secretary-designate, asserts there will be no absolute tax cut for the upper class because deductions would be scaled back. The rub is that totally eliminating all deductions for those with incomes over $1m would not even raise enough revenue to cover reducing their marginal tax rates from 39 to 33 per cent, let alone offset their benefit from huge rate reductions on business and corporate income, and the elimination of estate and gift taxes.

Estimates of the Trump plan suggest that it will raise the average after-tax income of the 0.9 per cent of the population with incomes over $1m by 14 per cent, or more than $215,000. This contrasts with proposed tax cuts for those in the middle of the income distribution of $1,000, or about 2 per cent.

The repeal of estate and gift taxes is especially problematic because it would provide a window for the very rich to use gift and trust structures to ensure that their wealth passes without tax not just to their children but to their grandchildren and great grandchildren, regardless of subsequent legislation.

The Reagan tax reform simplified the code by eliminating the need for rules distinguishing ordinary and capital gains income, because these were taxed at the same rate, and by doing away with industry-specific shelter provisions. In contrast, the Trump proposal creates sheltering opportunities by reducing to 15 per cent the tax rate on any income that can be characterised as coming from an incorporated entity. Rather than reducing targeted subsidies, it would establish a highly dubious 82 per cent credit — the highest in the world — for financial equity investments in infrastructure.

This would mean not only disproportionate tax reductions for the upper-income group that has seen its incomes rise most rapidly over the past generation. It would also mean grave damage to federal budget projections. The envisioned Trump tax cut is about the same size relative to the economy as the 1981 Reagan tax cut. It is worth remembering that Reagan, hardly a fan of reversing course or raising taxes, found it necessary to propose significant tax increases in 1982 and 1984 (the equivalent in today’s economy of $3.5tn over a decade) due to concerns about federal debt.

Today’s budget situation is much more worrisome. The baseline involves much higher levels of debt and deficits. Then the economy was suffering from a deep recession; now it approaches full employment. If extreme tax cuts are legislated in the next months, uncertainty about the federal budget and about further tax adjustments is likely to rise. Finally, I can find no basis in either economic history or logic for Mr Mnuchin’s claim that the proposed reforms would increase the economy’s growth rate from its current 2 per cent rate to the historical 3 to 4 per cent norm. Adult population growth has slowed by nearly a percentage point, the gains generated by more women entering the workforce have been exhausted, and it is far from clear why tax reform will hugely spur productivity growth.

Indeed, because the Trump proposal would redistribute after-tax income towards those most likely to save it, push up long-term interest rates because of debt pressures, increase uncertainty and the advantages of overseas production, it is as likely to retard growth as to accelerate it.

In the 1980s, treasury secretary Don Regan said the first Reagan reform proposal was written on a word processor to signal the administration’s openness to negotiation and radical alteration. We should all hope the Trump administration follows Reagan’s approach on both tax policy principles and a commitment to bipartisan negotiation.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary

Auctions will test investment appetite in Mexico after Trump victory in US

Some of the world’s best-known oil majors are expected to compete in a long-awaited auction for deepwater contracts in Mexico on Monday that marks a key opening of the country’s energy sector.

ExxonMobil, BP, Royal Dutch Shell and Chevron and China’s Cnooc are set to be among bidders for blocks in the Gulf of Mexico that have been off-limits to private investment for nearly eight decades.

”It is the start of the big oil game” in Mexico, said Pablo Medina, analyst at Wood Mackenzie, an energy consultancy.

The auctions will be the first big test of investment appetite in Mexico since Donald Trump romped to victory in the US election with populist pledges including renegotiating the North American Free Trade Agreement.

His Nafta pledge could, if realised, bump up exploration costs in Mexico if imports of heavy equipment needed for drilling were subjected to tariffs

Mexico has been opening up its energy sector to private investment under a sweeping reform programme and has already tendered shallow-water and onshore blocks in recent months. But the deepwater contracts that will be awarded on Monday are considered the crown jewels of the auction process so far because of the prospects for big discoveries.

Whereas the US side of the Gulf is chock-full with rigs and accounts for 17 per cent of US crude production, the Mexican side is still largely a blank slate.

Mexico is auctioning off four blocks in the Perdido Fold Belt, some 320km south of Texas, that show geological similarities to the US side and are close to important pipeline infrastructure. Six more larger blocks are on offer in the largely unexplored Salina Basin in the south of the Gulf of Mexico.

“If you want to shoot for the stars, that’s the Salina basin,” Juan Carlos Zepeda, head of the National Hydrocarbons Commission (CNH), which is running the tender, told the FT.

Eight individual companies and seven consortiums are expected to take part.

In addition, companies can also bid to partner with Pemex, Mexico’s financially troubled state oil company, in the deepwater Trion field, the first joint-venture in the company’s 78-year history.

Pemex is teaming up on Monday with Chevron and Japan’s Inpex, and has also qualified to bid individually. The CNH has not said which blocks companies are bidding for.

Pedro Joaquín Coldwell, energy minister, said success would be to award four of the 10 fields, which would not start producing for a decade if oil is found.

However Steve Otillar, an oil and gas partner with law firm Akin Gump in Houston, saw the prospect of “virtually all if not all being tendered. There are some great opportunities there and it’s a 10-year window — most people see prices recovering . . . they could be $80 per barrel by then”.

Prospective resources are nearly 11bn barrels of oil equivalent in the Perdido and Salina blocks, and potentially as much as 485m barrels of crude equivalent in Trion, according to the CNH.

While prospective bidders have applauded Mexico for making extensive seismic data available, that data showed the opportunities “are not as obvious as many companies thought”, said a senior official at one international company planning to bid.

Pemex is hoping that the 60 per cent Trion stake will bring in a total of $11bn in investment, while Mr Medina estimated investment of $3bn to $10bn per field in the case of discoveries.

With oil companies’ cash flows squeezed, the auctions come “in a very difficult pricing environment”, albeit “the sector is seeing light at the end of the tunnel”, said an executive at one company that is preparing a bid.

“Most of the ones that pulled out are midsized — they’re the ones that are struggling [in this price environment]. This is going to be a cash flow game,” said a senior official at a major that will take part.

Initially, 26 bidders, between consortiums and individual companies, had pre-qualified for the Perdido and Salina blocks and 10 had lined up for Trion, but a raft of companies, including Noble Energy of the US and Japan’s Mitsubishi Corp, India’s ONGC Videsh, Petrobras of Brazil, PetroCanada and Galp of Portugal, have dropped out.