U.S. Tax Cuts May Lead Companies to Take Too Much Risk, IMF Says

  • Trump tax plan could have unintended consequences, IMF warns
  • American firms already have high levels of debt, fund says

Tax cuts and financial deregulation proposed by the Trump administration could embolden American companies to boost risk taking to undesirable levels, the International Monetary Fund warned.

President Donald Trump has proposed cutting the corporate income-tax rate to 15 percent and taxing offshore earnings at a reduced level when companies repatriate the money. He has also suggested allowing firms to immediately expense capital spending, though they would have to give up their ability to deduct net interest expenses.

The plan would prompt U.S. companies to significantly boost capital spending, the IMF said Wednesday in its semi-annual Global Financial Stability Report. But the proposals may have the unintended consequence of causing companies to take too much risk, said the Washington-based fund.

“Cash flow from tax reforms may accrue mainly to sectors that have engaged in substantial financial risk taking,” the IMF said. “Such risk taking is associated with intermittent large destabilizing swings in the financial system over the past few decades.”

While U.S. corporate balance sheets are strong overall, cash flow has tapered and leverage has risen close to a historic high, with challenged firms concentrated in the energy, real estate and utilities sectors, according to the fund. Under an adverse scenario, an unproductive fiscal stimulus plan could trigger a sharp rise in interest rates amid tepid earnings growth, making it harder for firms to pay their debts, the IMF said.

Mergers, Acquisitions

History shows that tax policy changes have often been followed by increased risk taking such as mergers and acquisitions, the IMF said, pointing to a surge in risk after a tax holiday on offshore profits in 2004.

“Policymakers must balance the economic benefits of policy stimulus and tax reform against broader policy considerations and guard against financial stability risks,” the IMF said.

The fund also warned the U.S. against weakening banking regulations. “Although there is room to fine-tune existing regulations, policymakers should guard against wholesale dilution or backtracking on the important progress made in strengthening the resilience of the financial system, particularly at a time when balance sheet fundamentals are deteriorating
for U.S. companies.”

Trump has vowed to roll back the Dodd-Frank Act, a set of laws enacted after the financial crisis to discourage excessive risk taking, though the president has yet to outline his plan in full.

The IMF said global financial stability has improved since its last report in October, as economic activity has gained momentum amid loose monetary and financial conditions.

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