|
This blog post is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to see all of the blogs in the #TCJANowWhat series.
Corporate tax reform — specifically, the federal corporate rate cut to 21 percent — was a centerpiece of the December 2017 Tax Cuts and Jobs Act (TCJA). For decades, while other countries cut rates, the US did not change its corporate tax rate, resulting in the US having the highest statutory corporate tax rate in the developed world in 2017. Even when comparing effective tax rates, the US rate was well above that of the Organisation for Economic Co-operation and Development countries.
The TCJA provided a massive correction — or as some would say, overcorrection — by cutting the federal corporate tax rate by 14 percentage points. This dramatic change has received both plaudits and scorn. For some, like myself, the rate cut was seen as important to keep the US competitive against other countries as a destination for capital investment. In my own research with Kevin Hassett, data from other countries show that such changes in capital investment can lead to longer-run changes in wages for workers through increases in worker productivity. Recent studies similarly find that higher corporate taxes burden workers. For others, the rate cut signified a massive giveaway to corporations and rich shareholders with little to no impact on investment and worker productivity. Which view of the world is correct? Did the TCJA achieve its goal? If not, will it do so in years to come?
While it has been only a year and a half since the TCJA became law, there is some, albeit limited, evidence on how it is affecting the economy. Physical capital formation, as measured by changes in gross domestic fixed nonresidential investment, has grown 4.61 percent since the law’s passage in 2018. Equipment investment, which received special treatment due to the TCJA’s expensing provision, has also been growing since the TCJA. While some of this could be a result of the TCJA, the trend in both series looks similar to before December 2017. In fact, in the six quarters before the TCJA, domestic fixed nonresidential investment grew 5.6 percent. Hence, it would be fair to conclude that there has been no discernible break in trend since the TCJA for either series, though the tax law might have spurred some of these changes.
What about the impact on wages? Wages have been growing at a nominal rate of above 3 percent since the TCJA. Unemployment has dropped below what most analysts think of as full employment, and wages and incomes have both increased. Data from the Bureau of Economic Analysis show employee compensation rose 5.5 percent in 2018 and 3.4 percent in the first six months of 2019 alone. This is up from the 4.5 percent growth in 2017. Personal income grew 4 percent in 2018. Clearly, the labor market has been improving since the tax law was passed. But again, is it the result of the TCJA or part of the continuing postrecession recovery? Looking at the economy as a whole, real gross domestic product grew at 2.9 percent in 2018 and is projected to grow at 2.3 percent across 2019.
In short, a static snapshot of the economy looks good. But it is still hard to draw a link between the TCJA and these impacts. This is in contrast to other indicators that show the TCJA has had a discernible impact. Repatriations — when US corporations bring back and realize overseas profits in the US — are up. Repatriations saw a massive increase in the first quarter of 2018, and though the trend has slowed, repatriations are still well above their pre-TCJA levels. Additionally, inversions — when a US corporation restructures so it is headquartered in a foreign country, typically for tax purposes — are down. However, evidence suggests that the slowdown of inversions may have already begun due to regulations in 2014, 2015, and 2016.
So why are the investment and other impacts not noticeable in the data? The first explanation is simple. It’s been too short a time since the tax law was passed. Impacts on investment and wages are typically shown to occur over much longer periods, definitely longer than a year and a half. But a second big reason that receives less attention is that the TCJA did not simply provide a massive corporate rate cut for companies. Several other changes added a ton of complexity and uncertainty to the corporate tax code. Specifically, there were substantial changes in the international tax system that US multinationals have to adhere to. Under the earlier system, companies had an incentive to store profits overseas, since repatriated profits were subject to the high corporate rate of 35 percent. Several new provisions have now replaced that system of deferral. Instead of being able to avoid taxation indefinitely by keeping profits overseas, companies now owe a one-time tax on all previously accumulated profits stored overseas since 1986.
In addition, the TCJA established a new minimum tax (global intangible low-taxed income, or GILTI) that immediately taxes all foreign earnings that earn an above normal rate of profit (over 10 percent) at a rate of 10.5 percent until 2025 and 13.125 percent after. While this tax rate is lower than the new US corporate tax rate of 21 percent, it is effectively higher than the zero tax on foreign earnings under the old law that allowed deferral. So in many ways, the tax base subject to US corporate taxes is now much wider than before, which increases tax liabilities. In addition, the rules are not easy for companies to figure out. And as companies are learning, the expense allocation rules are in fact resulting in tax rates significantly higher than 13.125 percent.
Another tax, the base erosion anti-abuse (BEAT) tax, aims to limit profit shifting by disallowing deductions for certain related foreign party transactions. However, the tax applies to imports even from high-tax countries, resulting in companies facing high costs of operation in the US. This rate will increase from 10 percent currently to 12.5 percent starting in 2026, adding to the burden companies are already facing.
Finally, in a bid to lure intangible income to the US, a new foreign derived intangible income (FDII) provision allows companies a lower tax rate on the share of domestic earnings that are derived from export sales. While in principle this should encourage the location of capital in the US, the interaction of these different provisions has nearly everyone guessing about the implications for domestic investment. So it’s not surprising that companies may have put investment decisions on hold while these uncertainties get resolved.
In addition, several provisions are either set to expire or negatively affect companies. For instance, equipment expensing will start phasing out within the next three years, there is a limitation on the interest expense deduction to 30 percent of adjusted taxable income, and limits on net operating loss carryforward. Clearly, companies are dealing with a lot more than a simple corporate rate cut.
A final question is: How is the law playing out for American families? Many analyses show that most families received a tax cut because of the TCJA. As per the Tax Policy Center’s estimations, the average household paid approximately $1,600 less in 2018 than they would have under prior law, with middle-income households receiving a $900 increase in after-tax income. Using a micro-simulation model developed by AEI’s Open Source Policy Center, I find similar estimates. Here, Erin Melly presents estimations by decile for average changes in after-tax income. Recent analysis of IRS data shows that total amounts of tax refunds remained the same or decreased due to the TCJA for most income thresholds, except for the $250,000 to $1,000,000 income group.
These results make sense. The TCJA had numerous changes for individual filers; it doubled the standard deduction, expanded the child tax credit, and eliminated personal exemptions. It also cut marginal tax rates for all households by a couple of percentage points. The combination of these changes has allowed families to enjoy marginally higher post-tax incomes. For the richest taxpayers, who also used to benefit from the state and local tax (SALT) deduction, the capping of the deduction amount has resulted in marginally higher taxes paid. Other provisions have also raised taxes on high income earners. For instance, the expanded tax code Section 162(m) limits the deduction public companies can take for compensation of more than $1 million paid annually to executives. Under earlier law, companies were allowed a deduction of $1 million on performance-based pay. This deduction is now no longer available, which effectively means higher tax rates for companies and top executives.
To conclude, one simple narrative describes the TCJA: It cut rates for companies, but it created uncertainty through the GILTI, BEAT, and FDII. It cut marginal tax rates for all earners but also broadened the base by capping deductions on SALT and property taxes. For high earners such as executives, it further disallowed opportunities for tax planning. The TCJA also added to fiscal deficits, which has implications for economic growth going forward. If that isn’t enough, all of this is playing out in an economy that is facing trouble from the possible escalation of tariffs and a trade war and from uncertain global economic conditions. In short, teasing out the impacts of the largest tax overhaul the country has seen in decades on households and the economy will take time. So let’s be patient. It’s too early to give up on the Tax Cuts and Jobs Act.
Aparna Mathur is a resident scholar in economic policy studies at the American Enterprise Institute.
Return to the series
Teasing out the impacts of the largest tax overhaul the country has seen in decades on households and the economy will take time. So let’s be patient. It’s too early to give up on the Tax Cuts and Jobs Act.
|
|
