Income inequality is luxury’s best friend. Indeed, dynamics which elevate some but not others, goes hand-in-hand with luxury market growth. Flush with cash, people who get richer purchase designer handbags and flashy cars to confirm and communicate their freshly acquired status.
This axiom may best be epitomised by China, but it is no less applicable to the US: the underlying upward trend in American luxury spending over the past 50 years has gone hand-in-hand with growing income inequality. What’s more, increases and cuts into US marginal tax rates have caused lulls and spikes in luxury spending. So, it seems reasonable to expect President Trump’s tax reform — with federal tax rates slashed almost across the board — to be a boon for luxury goods companies. I don’t think this will be the case, however, at least not at the higher end of the market.
The problem with the reform is that it also eliminates important deductions. Prior to the reform, taxpayers could deduct state and local property taxes, as well as state income taxes and sales tax from their federal return. Going forward, these deductions will be killed or capped.
Although the reforms are applicable nationwide, the severity of the impact is regional, as state taxes are generally higher on the East and West coasts of the country than in middle America. So, high-income citizens on the coasts stand to gain the least or lose the most, with the hit being hardest on those in the higher income brackets.
Wealthy consumers where demand for luxury is highest are going to be worse off, likely denting sales.
Take two households, one with annual income of $100,000, the other $500,000. My modelling shows that whereas the former would be a net gainer in New York, California or Texas, the latter would be a net loser in New York and California, though better off in Texas.
Now, looking at where the big luxury groups have positioned their distribution networks, we see that megabrands like Louis Vuitton, Gucci and Cartier are all largely concentrated on the East and West coasts. In between, lies a high luxury desert. So, in sum, wealthy consumers where demand for luxury is highest are going to be worse off, likely denting sales.
The winners will be people living in the heart of the USA, where state taxes are generally lower. The tax reform is a net positive for them. These are, in many cases, the same people who voted for President Trump. They are also core consumers of American accessible luxury brands like Coach and Michael Kors, whose retail networks are more evenly distributed.
So, rather than a boon, maybe we should add US tax reform to the list of things that could moderate demand for luxury giants in 2018.
Luca Solca is the head of luxury goods at BNP Exane Paribas.