In the wake of the tax bill’s passage, President Trump promised the tax cuts would be “rocket fuel” for the economy, reflecting predictions from National Economic Council Director Gary Cohn of 4 percent GDP growth in 2018 and a prolonged period of wage growth.
However, according to several economists, the most commonly touted benchmarks for the effectiveness of the new tax law (P.L. 115-97) — a surge in GDP and wage growth — may not be the best way to measure its impact.
“It’s difficult to evaluate the impact of the tax bill from the performance of the economy because so many factors impact the performance, and because by its nature we can’t observe the counterfactual — what the economy would have done in the absence of the bill,” Benjamin R. Page of the Urban-Brookings Tax Policy Center told Tax Analysts.
Nevertheless, Page suggested that with the economy at full employment and the U.S. already deep into an economic expansion, he wouldn’t expect GDP growth to accelerate without any exogenous factors acting upon it. “So if growth is faster in 2018 than in 2017, I’d be willing to accept that as evidence the tax bill provided a boost, absent other factors during the year, such as a big decline in oil prices,” Page said. However, such growth would likely be only a “short-term Keynesian boost from increased taxable incomes and temporary investment incentives,” he added.
For Scott Greenberg of the Tax Foundation, there are two key questions determining how the economy might respond in the short term to the tax cuts: how close the economy is to its potential, and how quickly it can expand.
Determining the United States’ economic potential is a source of great uncertainty for economists, according to Greenberg. But regarding the pace of economic expansion, “there’s a case to be made that those responses don’t happen overnight.” For many business owners just now finding that the cost of investing in the U.S. is lower, “it might still take a couple years to plan and execute an investment that will ultimately make that business more productive,” he said.
Certain provisions in the tax law, like allowing full expensing, can help accelerate the pace of some of that decision-making, as business owners face a use-it-or-lose-it scenario when the provision expires beginning in 2023, according to Greenberg. That effect would likely show up in higher GDP growth figures, he said, but added that the very fact that the expensing provision is temporary means that it will have smaller economic effects.
Likewise, Greenberg said that other expiring provisions like the passthrough deduction, which is set to sunset in 2026 along with most of the other individual income tax provisions, may actually have a negative economic effect in some years. He explained that businesses would be taking deductions for capital spending against a lower passthrough rate, and then be taxed on the income from those capital investments at a higher passthrough rate once the deduction expires. “That’s a phenomenon that will, in general, lower the effectiveness of the passthrough deduction even for the years in which it’s in effect,” he said.
Wager on Wages
White House officials have acknowledged that wage growth thus far remains weak, but they’re betting that the tax reform law will help.
An October 2017 report by the White House Council of Economic Advisers, led by Chair Kevin Hassett, found that the corporate tax changes alone would lead to an additional wage growth of 2 percent per year, such that the average U.S. household would earn more than $4,000 more in annual wage income by 2021, and $9,000 more per year by 2024.
“The tax bill may somewhat strengthen the wage growth trends, but not as much as Hassett predicts,” said Alan Cole, an independent policy analyst.
Cole argued that the U.S. economy was already hitting a “turning point . . . that happens to coincide with the passage of the tax cuts.” He noted that with unemployment as low as it already is, businesses can’t just create new jobs because most people who want jobs already have them. Cole explained that businesses will instead need to compete for higher-skilled workers by offering higher wages, so barring a recession, 2018 and subsequent years would likely show significantly higher wage growth without the new law.
Cole also said that higher investment is linked to higher wages, so a high level of investment “would vindicate corporate tax cut boosters like Hassett.” But he added that with the U.S. economy already at its turning point, if wage growth increases but investment levels stay the same, “I wouldn’t credit the [corporate] tax cut for doing it.”
However, Aparna Mathur of the American Enterprise Institute suggested that there may be room for more job growth, as there are “still many workers sidelined in the labor market” who aren’t reflected in the employment rate. She also said that higher investment as a result of the tax law should lead to higher wages — “definitely faster than the 2.5 percent growth we are seeing right now.” She added that actual median household incomes might go up between $1,000 and $2,000 or more annually if some companies that are much better off under the tax law reinvest those additional profits.
Despite the uncertainty over how much credit to give Trump’s tax cuts for any potential economic boom in 2018, the economists Tax Analysts spoke to largely agreed with the White House’s own top economist about keeping an eye on at least one key economic indicator: capital investment.
“The sign that we really need to see if [the tax cuts are] working is that capital spending goes up as a share of GDP next year,” Hassett said at a December 13 event in Washington. If capital spending remains static or drops, “it’ll be completely fair” to question whether the cuts are working as the administration predicted, he added.
“This is the real marker of whether the tax cuts are working as intended,” Cole agreed. He noted that gross domestic private investment as a share of GDP has been lower than its historical average in recent years, at about 16 percent. If that indicator ticks up to 19 percent or 20 percent, “I’d believe the tax bill is working towards its intended effect,” Cole said.
Greenberg likewise said that generally, investment-related aggregate measures “are the most important to be paying attention to to see if the tax plan is having an effect.” But he also cautioned that those aggregates ideally should be observed over a period of years, rather than months, because investment decisions typically don’t happen immediately.
Page said that while he expects there to be at least some increase in the investment-to-GDP ratio, he has estimated that the effect would be modest — and short-lived.
Mathur also suggested that initially higher levels of investment in the economy would be an indicator that the corporate tax cuts in particular are effective. She declined to offer a specific number, however, instead suggesting that the objective would be to see investment trending upward over time.
Another indicator that the corporate tax changes are working is fewer corporate tax inversions, according to Mathur. “If companies think the U.S. tax rate is competitive, there should be less incentive to try to invert to a low-tax country,” she said.
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