U.S. tax plan could cause sugar high, then economic slump

By Megan Davies and Jennifer Ablan

NEW YORK (Reuters) - Slashing taxes may give the U.S. economy a temporary boost but the "sugar rush" may cause deeper problems ahead, investors at the Reuters Global Investment 2018 Outlook Summit in New York said.

U.S. equities have rallied this year, partly on hopes that promises by President Donald Trump to cut taxes will come to fruition. But while investors at the summit thought a cut would continue to boost equities and help corporations, some questioned whether the timing was right and worried about the impact on the country's deficit.

"I worry about a sugar rush which you crash harder from," said Gregory Peters, a managing director and senior investment officer at PGIM Fixed Income. "I don't know if it's necessary at this point."

Republicans in the U.S. House of Representatives and the Senate earlier this month unveiled dueling proposals to slash corporate taxes to 20 percent from 35 percent. The House passed its version on Thursday, and a Senate committee voted to send its version to the full Senate, which will take it up after the Thanksgiving holiday on Nov. 23.

Peters said the United States is at a "point in the cycle where fiscally you're supposed to get your house in order," adding that if it deteriorates fiscally "your fiscal impulse when you need it the most isn't available."

The U.S. economy has been showing steady but underwhelming annual growth since the last recession in 2007-2009 while the S&P 500 Index has risen around 15 percent.

While investors typically are not forecasting a near-term recession they see a risk from expanded stock market valuations which could cause a correction and have a ripple effect on the economy. While on the campaign trail in 2016, Trump forecast a "very massive recession" in the United States.

Joachim Fels, global economic advisor and a managing director at Pacific Investment Management Co (Pimco), said a recession could be hastened if Congress implemented tax cuts that overstimulate the economy, and used up bullets that lawmakers could use to fight the next downturn. He said it could "pave the way for a short boom now ... but possibly a recession in 2019 or 2020."

"I don't think we need a tax cut at this stage," said Fels. "A tax cut at this stage is raising the risk of overstimulating the economy."

Both measures would add $1.5 trillion over 10 years to the annual budget deficit and the $20 trillion national debt, according to congressional tax analysts.

White House spokeswoman Sarah Sanders said on Thursday a new tax code would be "rocket fuel" for the economy.

BlackRock Inc Chief Executive Officer Larry Fink said his worry is the potential for a long-term problem from the foreign funding of U.S. debt.

China was the largest non-U.S. holder of Treasuries while Japan was the second-largest in August, according to the latest data from the Treasury Department.

"These nations (China and Japan) are going to be moving from a saving society to a consuming society as people age," said Fink. "My fear is the dependency of foreign ownership of our debt should be an alarming issue. Demographics will kick into these other countries."

A tax cut as planned could also be bad for consumer spending, Avenue Capital Group co-founder Marc Lasry forecast.

"For corporations it is (good), but I actually think it's negative for the consumer," Lasry said, because some people would see tax bills rise.

While Republicans insist their goal is to help the middle class, Democrats have pointed to the loss of popular deductions as proof the legislation was an assault on those taxpayers.

The Senate plan would also guarantee permanent tax cuts for corporations but only temporarily lower tax bills for individuals and small businesses.

Still, there remains skepticism that a plan will advance. The efforts have been complicated by the proposals differing on several key fronts, raising the question on how realistic it will be to reconcile the House and Senate versions of tax reform.

IMMEDIATE BOOST

An analysis by the White House Council of Economic Advisers concluded lower corporate taxes would motivate companies to invest in new machines and hire more skilled workers. However, a number of U.S. corporations are saying they would use a tax reform windfall to buy back shares, retire debt and other shareholder-friendly moves.

"In general it should be helpful to us," Joel Greenblatt, a hedge fund and mutual fund manager at Gotham Asset Management in New York. The companies we like ... pay lots of taxes and if they pay less that's good."

Avenue Capital Group's Lasry forecast that the market would likely pull back if tax reform failed to materialize.

The Senate plan produced late on Tuesday would guarantee permanent tax cuts for corporations but only temporarily lower tax bills for individuals and small businesses.

Overall, Mario Gabelli, chief executive officer of GAMCO Investors Inc, said he anticipates a wave of merger and acquisition activity in all industries as details of the U.S. tax plan become clearer.

"You will have global lovemaking at an accelerated rate," he said. "Companies are ready to grow. ... They just need to have what the rules of engagement are."

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(Additional reporting by Jon Stempel; Editing by Lisa Shumaker)