Acceleration in wage growth in the US, strong GDP growth in the euro zone in 2017

Macro Highlights - 2/7/2018

In short
  • Economist insights: Acceleration in wage growth in the US, strong GDP growth in the euro zone in 2017
  • Focus US: How will Donald Trump sanction US (and foreign) multinationals? The BEAT

Key takeaways of the week from Lisa Turk - Economist, the United States, Sophie Casanova - Economist, Central banks
  • The employment report was solid in the United States: 200,000 new jobs were created in January and growth in nominal wages accelerated to 2.9%...
  • … we nevertheless continue to anticipate low growth in real wages in 2018 due to a slight increase in inflation
  • Euro zone GDP grew by 2.3% in 2017, its fastest pace in 10 years. It nevertheless could slow in 2018, due notably to the rise in the euro exchange rate

Acceleration in wage growth in the us, strong GDP growth in the euro zone in 2017

United states – despite an acceleration in wages, the increase in the purchasing power of households could remain limited if there is a slight rise in inflation as we expect

The US Bureau of Labor Statistics report for the month of January indicated 200,000 job creations in the country, 196,000 of which in the private sector. Unemployment was stable at 4.1%, its level since October 2017. With the number of part-time workers up by 74,000 in January (4,915 million in December vs. 4,989 million in January), the underemployment rate increased from 8.1% to 8.2%.

The notable aspect of this employment report was private sector nominal wage growth, which accelerated from 2.5% y-o-y in November to 2.7% in December and 2.9% in January, to attain an hourly wage of USD26.74. The January increase was above all driven by the financial, IT, business services, education and healthcare sectors. The increase in the minimum wage in 18 US states on 1 January 2018, ranging from USD0.35 in Michigan to USD1.00 in Maine, also explains this acceleration. Although the rise in nominal wages is in line with our scenario, we nevertheless do not expect it to lead to a significant increase in the purchasing power of households, as it could be offset by inflation. Thus, household consumption should not undergo a significant acceleration in 2018.

Our forecast of a slight increase in inflation in the US in 2018 was underscored by the Fed’s statement following its monetary policy meeting of 31 January. While the Federal Reserve maintained the fed funds rate at 1.50%, as we were expecting, it opted for a slightly more hawkish stance than before. The Fed notably indicated that it expected inflation to increase this year (its previous assessment was that inflation would remain below its 2.0% target in the short term) and underlined the fact that “further” gradual increases could be made. This communication is in line with our scenario that the Fed, which since 3 February has a new President, Jerome Powell, could raise its key rate by 25 basis points to 1.75% during its next meeting on 21 March.

Euro zone – GDP data confirmed that growth continued to be robust in q4 2017, but the rise in the euro should weigh on the outlook

Economic growth remained strong in the euro zone in Q4 2017. GDP increased by 0.6%, after 0.7% in Q3, and 2.7% after 2.8% on a year-on-year basis. For the full-year 2017, GDP growth came out at 2.3%, compared to 1.8% in 2016, its highest pace since 2007. Changes in the GDP components were not released along with this first estimate. Figures for France nevertheless showed that external trade contributed 0.6 of a percentage point to quarterly GDP growth, which worked out at 0.6%, after 0.5% in Q3 (2.4% in Q4 after 2.2% in Q3 on a year-on-year basis, and 1.9% over 2017 vs. 1.1% in 2016).

This trend supports our scenario according to which activity in the euro zone continued to benefit at end-2017 from both stronger global demand and the past decrease of the euro. The 9.8% appreciation in the effective exchange rate (i.e. the exchange rate against a basket of currencies) of the euro since April 2017 could nevertheless gradually weigh on economic growth in 2018. Moreover, the Economic Sentiment Indicator published by the European Commission was down slightly in January from 116.0 to 114.7, which tends to confirm a possible slowdown in growth. We maintain our GDP growth forecast of 1.8% for the euro zone in 2018.

Lisa Turk - Economist, the United States,
Sophie Casanova - Economist, Central banks,

FOCUS US : How will Donald Trump sanction us (and foreign) multinationals? The beat

The highlight of the tax reform signed by Donald Trump on 22 December 2017 was the cut in the corporate tax rate from 35% to 21%. However, the reform also provides for other measures that could, for some companies, partially offset this advantage. The Base Erosion and Anti-abuse Tax (BEAT) is one of these measures. It aims above all to tax US and non-US companies operating in the US that deduct from their tax base a significant amount of payments made to their subsidiaries or parent company in other countries. Intra-group payments concerned by the tax can notably include interest payments, royalties for intellectual property and patents. While all large US companies and the subsidiaries of foreign multinationals are potentially affected by the BEAT, which is in effect since 1 January 2018, certain companies are likely to suffer more than others.

Large financial institutions operating in the US could notably be penalised by the new measure. Indeed, their US subsidiaries are very often financed through loans from their parent company established in another country. The US entity then pays interest to the parent company, which is deductible from its corporate tax base in the US. Now, the subsidiary will pay an additional 10% tax on the sum of these interest payments and the corporate tax base, from which will then be deducted the amount of corporate tax paid (see equation below). This could represent a significant tax increase for the financial institution at the group level. It is on this basis that IIB (the Institute of International Bankers), representing around a hundred non-US banks operating in the US, condemned this measure as discriminatory.

1 – The BEAT, a tax that mainly affects US and foreign multinationals

The BEAT will be determined by the difference between a) 10% of taxable income including the intra-group payments concerned and b) the tax liability, i.e. the tax already paid in the US, minus certain tax credits. In other words, the BEAT ensures that US-based companies pay a minimum 10% tax on their taxable income before payments to foreign subsidiaries or the foreign parent company.


The BEAT will be calculated as follows:
BEAT = (10% * of taxable income including the cross-border payments) – (tax liability – certain tax credits)

The tax will be applicable to US entities with gross yearly revenues of at least USD500 million (in the past three years) and for which the share of intra-group payments is higher than 3% of all deductible expenses (2% for financial institutions)[1]. This means that the companies affected by this measure are above all large - US and foreign - multinational groups that have subsidiaries on US soil and that have significant flows - interest or royalties, for example - towards overseas entities. Industrial groups could partially avoid the tax, as payments for goods – and more specifically the cost of goods sold – will be exempt from BEAT (see chart above).

The measure aims to reduce the incentive for companies to significantly employ profit transfers or high transfer pricing[1] toward intra-group entities based in other countries, notably those offering tax advantages. This practice of eroding the tax base by companies has also been denounced by the OECD in its Base Erosion and Profit Shifting (BEPS) programme.

2 – Some multinationals will be penalised more than others

In order to understand which US companies could be affected by the BEAT, we analysed the profits of S&P500 companies generated outside the US. The aim is to compare the portion of income generated abroad with that of actual activity recorded outside the country. Because company financial reports are not standardised, we used the data collected by Bloomberg on the geographical breakdown of the operating income of 71 companies of the S&P500 (see table below). This data does not provide an exhaustive representation of the situation of US companies, but nevertheless enables us to determine the impact that the BEAT could have.

On average for the 71 companies, the income and revenues recorded overseas in proportion to their respective totals are equivalent, i.e. 39% for the 2016 fiscal year. However, some companies record overseas operating income that exceeds 60%-70% of their total income, while their revenues generated outside the US only represent 20%-30%. These companies will be especially affected by the BEAT, which aims to reduce these disparities by ensuring a minimum tax on intra-group flows out of the US. According to the Bloomberg data, technology and pharmaceutical companies could be affected the most by the BEAT. These two sectors record income outside the US that represent on average 67% and 64%, respectively, of their total income, while their foreign revenues represent only 43% and 46% of their total revenues. In addition to transfer pricing, there is a high level of royalties in these sectors.

Implications :

  • The BEAT aims to offset the advantages of intra-group payments that are deductible from the corporate tax base. Its objective is to subject US entities to a minimum tax of 10% on their taxable income before payments are made to foreign entities.
  • Large international companies are likely to be more greatly affected by the BEAT than domestic companies that do not have foreign subsidiaries. For some multinationals, the benefits of the cut in the corporate tax rate from 35% to 21% could be partially offset by the BEAT.
  • The data analysed indicates that some companies record a higher share of profits outside the US than revenues. The BEAT aims to reduce this gap between income and revenues recorded outside the US.
  • The Joint Committee of Taxation estimated that the BEAT tax will increase government revenues by USD149.6 billion over 10 years, while the overall tax reform is set to result in a drop in revenues of USD1,456 billion over the same period.

Corporate tax cuts should favour the industrial, energy and consumer goods sectors, which according to our forecasts are set to support fixed investment in machinery and equipment in these sectors. The BEAT tax should enable a transfer of resources notably from the technological and pharmaceutical sectors toward more traditional sectors. Overall, we expect the acceleration in corporate investment, from 4.7% on average in 2017 to an estimated 6.4% in 2018, to be one of the growth drivers of US GDP this year.

Lisa Turk - Economist, the United States