On Nov. 8, 2016, the world took a step into the unknown when the U.S. electorate determined that Donald Trump would be the 45th President of the United States of America. In many ways, this step into the unknown was exactly what the electorate wanted, it meant some fresh ideas, an outwardly successful businessman untainted by the Washington “swamp” taking charge and a change from the stale policies and unloved political correctness of the political classes in Washington.
However, the global financial industry does not thrive on uncertainty and much time and effort has been spent attempting to work out precisely what this ‘breath of fresh air’ will bring, both to the U.S. and to the offshore financial industry of which the Cayman Islands is a part.
In looking for clues the obvious place to start is with President Trump’s campaign statements on the economy which strongly imply that, amongst other things, he wants to remove regulation from the U.S. economy; he wants to simplify U.S. tax codes; he wants jobs, especially those in the manufacturing industry, to be kept in the U.S. and he also wants to get rid of most corporate tax loopholes or incentives. However, only on the matter of taxes does Trump provide any clue to how this might play out, as this was the one area in which he had been both outspoken and specific having released a detailed proposed tax plan which set out his goals as:
- tax relief for middle class Americans;
- simplification of the tax code;
- growing the U.S. economy; and
- not adding to U.S. debt and deficit.
Clearly, the tax cuts were and are a key part of Trump’s appeal to sectors of the electorate but it is the impact on business and the economy that is of primary concern.
President Trump’s “America First” budget also provides an indication of his plans as the budget offsets large increases in defense spending, homeland security and veterans affairs with huge cuts to the environmental protection agency, the departments of labor, education, housing, transportation and state, USAID and international programs. Indeed, virtually every agency will see some sort of cut. Nonetheless, as is usually the case for Trump, his budget has come in for widespread criticism and lawmakers have already expressed opposition to many of the proposals.
Rather than a systematic review of all Trump’s, sometime contradictory, statements and policies, this article proposes to look at the threats and the opportunities provided by Trump to the offshore industry and the Cayman Islands in particular.
The U.S. as a low tax jurisdiction
President Trump’s proposed tax plans envision the slashing of corporate taxes from 35 percent to 15 percent, and Trump has said he would apply the rate of 15 percent to all types of business income. The Tax Policy Center estimates the Trump plan will lower federal tax revenue by $6.2 trillion over the next 10 years, which would, on the positive side, have the effect of spurring investment in the U.S.
However, such a plan does have side effects that would adversely impact the Cayman financial industry – in particular, by implementing a “low-tax: strategy, the competitive advantage of Cayman as a non-tax jurisdiction is significantly reduced. In some cases, this reduction may be significant enough that there would be no real advantage in using a Cayman structure at all. So, while the onshore or U.S. financial industry as a whole may benefit, the offshore industry may be detrimentally affected as Cayman matters are restructured as purely onshore transactions.
Repatriation to the U.S. of funds held offshore
The proposed tax plans contain details of a plan to end the deferral of taxes on corporate income earned abroad and the implementation of a one-time, 10 percent tax on cash held overseas to be repatriated. This is aimed at halting the practice of U.S. multinationals holding hundreds of billions of dollars in offshore accounts, many of them in the Cayman Islands, to reduce their U.S. tax liability. It would potentially result in billions of dollars held by U.S. multinationals in Cayman entities being repatriated to the U.S.
President Trump appears keen to push this plan, as he told reporters on the campaign trail in October 2016 that his advisers “think it is $2.5 trillion” in corporate cash that is held offshore. “I think it is much more than that and, boy, if it is, we have hit pay dirt.” The Congressional Research Service estimates large corporations are legally avoiding $100 billion in U.S. taxes by not repatriating profits earned abroad. Activist group Citizens for Tax Justice believes the figure is much higher. A report by Citizens for Tax Justice published in March 2016 claimed that Fortune 500 companies alone avoided $695 billion in U.S. federal income tax on $2.4 trillion in offshore holdings. The example of technology company Apple was cited as it maintains about $200 billion in foreign earned income as cash, cash equivalents and marketable securities in offshore entities.
Key to Trump’s overall plans is the policy of not adding to the U.S. deficit or national debt. However, as a number of Trump’s proposed policies or campaign promises either include increases to U.S. spending (such as the proposed increase to military spending and the building of the Mexican wall) or cuts to U.S. taxes (such as the tax relief for middle class Americans and reduction of U.S. corporation tax to 15 percent) simple mathematics suggests that the U.S. government may well have to start looking into alternative sources of revenue. While Wall Street breathed a sigh of relief that the Democrats’ “Transaction Tax” was no longer following Donald Trump’s election, it is by no means clear that the financial industry will not see some form of taxation. Since Jan. 24, 2013, when the U.S. House Ways and Means Committee initially released a discussion draft of a bill to reform financial products, taxes on derivatives and other financial products have been mooted and discussed in Washington. Senate Finance Committee Ranking Member Ron Wyden, released a legislative discussion draft on May 18, 2016, that proposed a simplification on how derivative financial products should be taxed – the Modernization of Derivatives Tax Act or MODA. Interestingly, the Joint Committee on Taxation estimated that the changes proposed in MODA would increase U.S. tax revenues by $16.5 billion over 10 years. While neither MODA nor the House Ways and Means draft bill have progressed to become law, it is unlikely that a revenue hungry administration in the White House will not at least consider the financial industry – and the offshore financial industry in particular – as a possible source of new revenue. It is therefore not beyond the bounds of possibility that Trump may at some stage seek to use the offshore industry as a means of funding his more populist plans.
Use of offshore financial vehicles
Steven Mnuchin, President Trump’s Treasury Secretary, was forced to defend his use of offshore jurisdictions to the Senate finance committee when financial disclosures that he is the director of a Cayman Islands-based investment fund were provided to the confirmation hearing.
Mnuchin told the Senate finance committee that the use of such offshore tax havens is a consequence of the U.S. tax system. “I think it makes no sense to encourage hedge fund managers to set up entities in the Cayman Islands or anywhere else,” Mnuchin told the committee after being asked about his use of such entities. “I would like to work with the IRS to close these tax issues that make no sense, to make sure we are collecting the proper amount of taxes.”
When asked if he would support closing tax loopholes that make offshore tax jurisdictions so lucrative, Mnuchin said: “I would support changing the tax laws to make sure they are simpler and more effective.”
While not comprehensive, it is clear that Trump’s Treasury Secretary is willing to scrutinize U.S. tax laws in order to ensure that offshore tax jurisdictions such as the Cayman Islands are not as attractive or as easily accessed as they currently are. However, the Treasury Secretary’s careful wording does indicate that the relationship between the U.S. and offshore financial centers such as the Cayman Islands will not terminate completely.
President Trump has stated that he likes to be unpredictable. Indeed, in his first major foreign policy speech of his election campaign, he declared that, “we must as a nation be more unpredictable….” However, it is this very uncertainty which may be the greatest threat to the offshore industry. Unpredictability in a populist president, who may be hungry for revenue and appears prepared to lash out at those who do not agree with him, is not an ideal foundation for the development of the offshore financial industry and prudence would dictate that industry players proceed with caution.
Much has already been made of Trump’s campaign promises to remove regulation from the U.S economy. His willingness to proceed with this policy has been evidenced in his executive order reversing the financial restrictions introduced under the Dodd-Frank legislation. There is no guarantee that this policy will continue or that Trump will be able to implement legislation to remove the restraints on the financial industry imposed by Dodd-Frank or other regulations. However, on the assumption that he can, the financial industry could see a wave of work as capital tied up by existing regulation is freed and economic activity goes up due to lower business costs, thereby benefiting both the finance industry in general and offshore financial industries such as the Cayman Islands.
Capital investment and infrastructure spending
Steve Eisman, managing director of Neuberger Berman, who predicted the 2008 financial crisis, has expressed the view that growth in the U.S. economy is likely to remain anemic and U.S. interest rates are likely to remain low until the U.S. begins to invest in its infrastructure and begin a program of capital expenditure. At the time of the ABS East 2016 conference in Miami in September 2016 and Eisman’s address to the finance industry, such a program of investment seemed unlikely under President Barack Obama or the then likely future president, Hilary Clinton. However, with Trump agitating for both a huge wall along the southern border of the U.S. and a domestic infrastructure program, key factors are clicking into place which suggest that in the near future the U.S. economy will start to show signs of growth and the finance industry will see U.S. interest rate rises which financial markets are already in the process of factoring into their forecasts. Clearly, these factors will be beneficial to the financial industry and there will be a knock-on effect to the industry in the Cayman Islands.
Invariably linked to Trump’s plan to cut U.S. tax rates, the adoption of a low tax strategy by the U.S. is likely to slow down global initiatives that seek to harmonize corporate tax rates worldwide by targeting the zero or low tax rates of offshore centers such as the Cayman Islands. This would certainly ease some of the pressures on the financial industry in the Cayman Islands and would change the focus of such initiatives. Dan Mitchell, economist for the CATO Institute think tank and Cayman Financial Review editorial board member, said, “A potential silver lining to Trump’s victory is that his administration presumably will be much less sympathetic to OECD anti-tax competition schemes. And his proposal for a 15 percent corporate tax rate will put America in the pro-tax competition camp.”
In conclusion, the political landscape of the U.S. has been markedly changed by the election of Donald Trump and there is no clear, concise policy coming from the U.S. president with respect to the relationship of the Cayman Islands and the U.S. financial industry. Even the statements, policies and “America First” budget plans that have been published or otherwise made their way into the public domain from Trump and his spokespersons are not hugely reliable, given Trump’s tendency to walk back from many of his campaign commitments.
However, that said, the Cayman Islands are the strongest of the offshore jurisdictions and have a well-developed relationship with the U.S. and there appears to be no real desire in Washington to disrupt the status quo with an industry that does facilitate the investment of hundreds of millions of dollars into the U.S. economy every year.
It would be easy to sit on the fence and argue that there is too much uncertainty to paint a picture of how he will affect the offshore financial industry in general and the Cayman Islands in particular.
However, I would argue that, at this point in time, we have a U.S. economy that has been left in relatively good shape by the previous incumbent of the oval office and the opportunities currently afforded to the financial industry by President Trump ever so slightly outweigh the threats that he poses to the Cayman Islands. On that basis, it is my view that the U.S. financial industry and the U.S. economy in general will pick up in the short to medium term and that the knock-on effect of this will be steady, continued growth for the offshore financial industry and the Cayman Islands.
That said, in the longer term, too much deregulation by Trump may eventually result in the fracturing and breakdown of the U.S. financial industry. Take the Dodd-Frank regulations, which are aimed at preventing big banks from taking the kind of highly leveraged risks that resulted in the banking system teetering on the brink of collapse in 2008. Repealing such regulations simply allows the banks to make the same mistakes again and take the same highly leveraged risks that made them huge profits during the boom years.
It is easy to say one can learn from one’s mistakes; history shows that we don’t. In any event, the consequences of rolling back regulations is likely to take many years to materialize. As and when it does, the impact on the Cayman Islands and its financial industry will be significant indeed.