July 14, 2016 – On June 23, voters in the United Kingdom (UK) voted to exit — or “Brexit” — the European Union (EU), causing key stock market indices to fall for two days and leading many commentators to make any number of predictions. Nevertheless, the long-term effects of the Brexit referendum are unlikely to become clear for some time.

Background

The 28-member EU governs itself with a set of rules designed, generally, to reduce and/or eliminate barriers to the free movement of goods, services, capital, and people among the member countries. Economically, nations gain numerous trading advantages through membership, including zero tariffs on all imports and exports between EU members.

Prior to the Brexit vote, most experts had concluded that an exit from the EU would adversely affect the UK economy over the long term. The primary reason is that the EU is the UK’s largest trading partner, receiving about half of the UK’s exports of goods and services.

Most experts had also concluded that the UK’s exit from the EU would affect the UK much more than the EU. Although the UK has the second largest GDP in the EU, the combined GDP of the other 27 members is five times greater than the UK’s, and it is nearly as large as that of the United States (US).

In the aftermath of the vote, the UK is now required — over the course of the next two years — to negotiate with the EU over post-Brexit trade terms, and the EU is likely to insist on terms that will discourage other EU members from making their own exits.

Economic Effect on the US

The economic effect on the US is difficult to predict. On June 15, Federal Reserve Chair Janet Yellen stated that the Fed had continued to hold off on a rate increase in part because the Brexit referendum “could have consequences for economic and financial conditions in global financial markets.”

While the US exports only a small percentage of its goods to the UK, a larger percentage goes to the EU. As the UK separates itself from the EU, different rules will govern trade with each entity.

Whenever the British pound falls against the dollar — as it has recently — firms exporting to the UK will find themselves at a price disadvantage. And the dollar’s recent gains compared with a broad basket of currencies and the euro, albeit smaller in percentage terms, could place further pressure on U.S. exporters.

Financial Markets

Though major US stock market indices fell sharply in the two trading days following the Brexit vote, they quickly recovered. Markets may continue to experience volatility as the ramifications of the Brexit vote are clarified.

Travel

On a positive note, when the British pound loses value against the dollar, vacationing US travelers will see their money go further in the UK.

For more information, please contact Teresa Majors at tmajors@dopkins.com.

About the Author

Teresa M. Majors CPA

Teresa, the first woman at Dopkins to be named partner, works with local public and private companies providing assistance with intricate tax compliance, and tax planning. She has broad based experience including working with both public and private companies and their executives and owners. She has extensive experience with multi-state corporations, consolidated return issues, mergers and acquisitions, and tax provision issues.