Question

In 2017, the Trump administration enacted a significant tax reform that lowered taxes for individuals and corporations. In fact, it was the largest corporate tax cut in US history. Trump and his administration argued that the government would raise more tax revenue by reducing the marginal tax rates. Why were (and are) most economists skeptical about this argument?

Answer 1

ANSWER-

President Donald Trump and Republicans in Congress cut the corporate tax rate from 35 percent to 21 percent via the Tax Cuts and Jobs Act of 2017 (TCJA). At the time, the Trump administration claimed that its corporate tax cuts would increase the average household income in the United States by $4,000. But two years later, there is little indication that the tax cut is even beginning to trickle down in the ways its proponents claimed.

Corporate revenue has dropped precipitously since Trump’s tax cut

While the promised benefits of Trump’s corporate tax cuts have yet to materialize, the costs can be seen dramatically in the data on corporate tax revenue. As a result, since the law passed in December 2017, revenues from corporate taxes have fallen by more than 40 percent, contributing to the largest year-over-year drop in corporate tax revenue that we have seen outside of a recession. This has added even more to deficits than experts had previously predicted. The U.S. Treasury reported that from fiscal year 2017 to FY 2018, the federal budget deficit increased by $113 billion while corporate tax receipts fell by about $90 billion, which would account for nearly 80 percent of the deficit increase. Though the Trump administration and the Congressional Budget Office (CBO) projected corporate revenues to bounce back somewhat in FY 2019, there is no sign yet that that is happening, with 11 of 12 months having already been reported for FY 2019.

The Trump administration claimed its corporate tax cuts would translate into a $4,000 raise for the average household

In selling the large corporate tax cut to Congress and a skeptical American public, the Trump administration claimed that corporate tax cuts would ultimately translate into higher wages for workers. The tax cuts would trickle down to workers through a multistep process. First, slashing the corporate tax rate would increase corporations’ after-tax returns on investment, inducing them to massively boost spending on investments such as factories, equipment, and research and development. This investment boom would give the average worker more and better capital to work with, substantially increasing the overall productivity of U.S. workers. In other words, they would be able to produce more goods and services with every hour worked. And finally, U.S. workers would capture the benefits of their increased productivity by successfully bargaining for higher wages.

If ever the U.S. economy could use a strong tax cut tail wind, it could use one now as conditions weaken around the world.

But the tail wind isn’t there.

Instead, benefits from what President Donald Trump called “the biggest reform of all time” to the tax code have dwindled to a faint breeze just 20 months after its enactment. Half of corporate chief financial officers surveyed by Duke University expect the economy to shrink by the second quarter of 2020. Two-thirds expect a recession by the end of next year.

Corporate executives blame the darkening outlook on Trump’s trade war with China. The president blames mismanagement by Jerome Powell, the Federal Reserve chairman he appointed.

But economists who have examined the impact of the 2017 Tax Cuts and Jobs Act say it isn’t helping much in any of the ways advocates once advertised: overall growth, business investment, or worker pay. The strongest current case for the law’s economic benefits is that it remains too early to see them.

Most broadly, the tax cuts have not generated the promised growth of 3% or more – even in tandem with the additional stimulus of large government spending increases that Congress enacted separately. After an uptick in the second quarter of 2018, growth declined in the next two quarters to end up at 2.9% for the year.

Goldman Sachs economist Jan Hatzius says that second-quarter surge – initially measured at 4.2% but later revised down to 3.5% – represented the tax law’s peak impact. He expects it to vanish altogether by late this year or early 2020, as the economy returns to the same 2% growth levels Trump inherited from President Barack Obama.

Those levels assure the failure of another tax cut promise. Trump and congressional Republicans insisted the law would spur so much economic activity that surging new revenues would replace those lost through lower tax rates.

In reality, deficits have soared back toward the $1 trillion mark reached during the Wall Street crisis and Great Recession a decade ago. A Congressional Research Service analysis concluded that the law has produced no more than 5% of the growth needed to offset tax cut losses.

Tax cut backers painted a picture of robust new business investment that would revive American manufacturing and create good-paying jobs at home. But investment and manufacturing have slumped so much lately that Powell cited their weakness in announcing interest rate cuts last month.

Economists say the improved 2018 growth resulted largely from the boost in aggregate demand generated by tax cuts and spending hikes. Increased demand was itself limited by the fact that so much of the tax cut proceeds went to higher-income households with lower propensity to spend.

Today, “the economic benefits of the Tax Cuts and Jobs Act seem to have petered out,” Tax Policy Center analysts wrote early this month. “The economy’s strength now seems to lie almost entirely with consumer spending.”

Like overall growth, business investment spiked temporarily in 2018. Economists disagree on whether that stemmed from new incentives in the tax cut law or just oil price increases that encouraged more domestic energy production.

An analysis by Alexander Arnon at the University of Pennsylvania’s Penn Wharton Budget Model found that the rising price of oil “explains the entire increase in the growth rate of investment in 2018.” The Penn Wharton Budget Model is directed by Kent Smetters, a former economist for President George W. Bush.

The idea that lower taxes would boost business investment sounds intuitive. But in examining lackluster investment growth after the 2017 tax cut compared with earlier ones, International Monetary Fund economists this spring identified an explanation: corporate consolidation has freed dominant firms with high profit margins to invest as they choose with less regard for government tax rates.

“In an environment of rising market power, corporate tax cuts become less effective at raising investment,” the IMF economists wrote.

The economic expansion that began in 2010, now the longest in American history, has driven unemployment down to a 50-year low. But there’s no sign the tax cut has fattened paychecks very much for average workers.

The employee bonuses companies announced with fanfare after the tax cut passed, across the entire labor force, averaged $28 per worker based on the total payouts tabulated by an organization called Americans for Tax Fairness. Wages have risen faster than inflation, but not by much.

“Real wages increased by 1.2%” in 2018, the Congressional Research Service reported. “Ordinary workers had very little growth in wage rates.”

The 2017 tax cut’s international provisions reduced incentives for U.S.-based multinational corporation to attribute profits to overseas subsidiaries taxed at lower rates. Trump had predicted that would jump-start the economy by bringing trillions of dollars back to the U.S.

But a Federal Reserve study of initial results found “no obvious spike in investment” among the 15 companies holding the most cash abroad. Those firms had easy access to investment capital before the tax cut, the study noted, and instead boosted stock buybacks to reward their existing owners.

None of this precludes the tax cut bill from producing economic benefits over time. Republican economist Doug Holtz-Eakin has noted, for example, that many of the corporate stock buybacks benefit nonprofit entities such as pension funds with incentives to channel the proceeds into new investments.

Testifying before Congress earlier this year, Holtz-Eakin found “promising indicators” in the 2018 growth and investment increases while cautioning that it’s too early for definitive judgments. He pointed to other arguments for the 2017 tax bill in any event.