Fiscal battles are heating up in the US. A key focal point is likely to be the 2017 Tax Cuts and Jobs Act (TCJA), whose major provisions are slated to expire at the end of 2025 unless actively renewed. This legislation has been controversial from the start, and its looming deadline is sure to provoke intense debates again – about its macro-economic impacts, distributional effects, and budgetary consequences.
Below, we take a closer look at the TCJA as well as some novel studies which attempt to discern its impact on domestic business investment, long-term growth, and wages, as well as on the US government deficit.
The conclusions offer fodder for proponents and opponents of the tax act. The analysis reveals strong, positive impacts on business investment arising from lower corporate tax rates and the expense-provisioning aspects of the TCJA. All else equal, that ought to promote higher trend growth, even if the gains are difficult to measure and apt to be modest. Wage gains are evident, though they are small. Finally, the corporate tax cut is not likely to be self-financing: Future revenues owing to greater domestic economic activity are unlikely to offset the lost revenues due to lower tax rates.
TCJA: A Brief Refresher
TCJA was sweeping in scope. Though it included significant changes to individual taxes, the most profound overhaul was on the corporate side. Motivated by a desire to lift domestic investment by improving the international competitiveness of the US corporate tax system, the main changes included:
- cutting the corporate income tax rate from 35% to 21%;
- allowing immediate expensing of equipment investment (for a limited duration);
- shifting to a territorial tax system, with corporations no longer taxed on repatriated foreign profits but instead paying a 10.5% tax on Global Intangible Low-Taxed Income (GILTI) – foreign income in excess of 10% of foreign tangible capital (after allowances for 80% of foreign taxes paid);
- instituting a deduction for Foreign Derived Intangible Income (FDII).
Advocates argued that by lowering the after-tax user cost of capital, these measures would unleash a whirlwind of domestic investment, boosting US productivity and potential output, with much of the benefit ultimately redounding to workers (to the tune of a $4,000-$9,000 boost to average household labor income). Importantly, proponents claimed that the gains in GDP unleashed by the TCJA would raise sufficient tax revenues to offset those from the initial tax cut.
1 https://www.crapo.senate.gov/imo/media/doc/2017DEC-CEAReportTaxReformandWages.pdf
Others were skeptical. They countered that the impacts on investment and growth were wildly exaggerated, that the benefits that would ensue would be reaped largely by the (disproportionately wealthy) owners of corporations, and Treasury would lose substantial revenue.
The controversy hardly died down after the law was enacted. Supporters pointed to the strong growth and solid wage gains of 2018-’19 as evidence that TCJA worked as advertised, while detractors argued that it ate into Treasury revenue and firms used the tax savings to buy back shares and lift dividends rather than invest. Not surprisingly, the battle lines betrayed political leanings. We should expect more of the same as the expiration deadline approaches.
So who’s right?
It is difficult to disentangle the effects of TCJA from everything else that’s happened, especially using only macro data. A closer look at what individual firms have been doing could provide much-needed color. Fortunately, a recent study has obliged.
How did firms respond to TCJA?
Accessing individual corporate tax returns, a team of researchers sought to tease out the effects of TCJA’s main corporate tax provisions. What aided their efforts is that TCJA did not affect firms equally. Some were impacted more than others, depending on their taxable income, tax credits and deductions, depreciation schedules of investments, extent of their international operations, and so forth.
This heterogeneity can help answer some key questions. In particular, did investment vary systematically across firms depending on how much they were affected by TCJA? The short answer seems to be a resounding “yes.”
Impact on investment
The authors calculated a cost of capital and marginal tax rates for the domestic and foreign operations (if any) of each firm (reflecting the effects of tax rates,
2 https://www.heritage.org/markets-and-finance/commentary/the-trump-boom-no-mere-sugar-high
3 https://www.brookings.edu/articles/searching-for-supply-side-effects-of-the-tax-cuts-and-jobs-act/
https://www.heritage.org/taxes/report/economic-history-the-tax-cuts-and-jobs-act-higher-wages-more-jobs-new-investment
4 https://www.nber.org/system/files/working_papers/w32180/w32180.pdf
expensing allowances, FDII, GILTI, etc.), both pre-and post-TCJA. They then compared these variables to each firm’s investment. Tellingly, they found strong, statistically significant elasticities. Firms with bigger declines in the cost of capital and marginal tax rates post-TCJA had bigger increases in domestic investment (they even found a powerful response to a decline in a firm’s foreign cost of capital, suggesting a complementarity between foreign and domestic investment.)
The effects were sizable. Firms experiencing the mean change in the cost of capital and tax rates induced by TCJA saw 20% more domestic investment compared to firms experiencing no change. And since their pre-2017 investment patterns were similar, a causal interpretation of the post-TCJA responses seems plausible.
The researchers further validated their results by comparing a set of US firms to a control group – a set of foreign firms similar in size and investment behavior prior to 2017 but not directly impacted by TCJA. They found that investment by US firms was about 15% higher than the foreign control group in the two years after TCJA.
The results of this study are not an outlier. They’re comparable to estimates from analyses of past corporate tax policy changes, if perhaps at the lower end of the range, and similar to those found in another recent study of TCJA that estimated investment elasticities by exploiting variation in the tax cut across C- and S-corporations of comparable size.
Long run, macro effects
By a simple extrapolation of their regression coefficients, the authors estimate that TCJA would lift the domestic capital stock of the US corporate sector about 16% in the long run. Factoring in various dampening feedback effects, however, cuts this by a bit more than half. For example, they estimate that the rise in domestic capital lifts domestic wages about 1% in the long run (well shy of what TCJA’s promoters claimed), which cuts into profits and eventually tempers the increase in investment. And if accelerated expensing phases out as scheduled in TCJA, the rise in capital would be smaller still. Indeed, accelerated expensing, if made permanent, accounts for more than one-quarter of the estimated long run increase in the capital stock from TCJA – second only to the effect of the cut in the corporate tax rate itself.
5 The authors assumed that prior to TCJA firms anticipated they’d be given a temporary window for repatriating foreign subsidiary income (as sometimes happened in the past) at a rate of 10.5% — the GILTI rate – which lies in the range of the transition rate under TCJA.
6 By excluding foreign income up to 10% of foreign tangible capital from taxation, the GILTI provision lowers the foreign cost of (tangible) capital, and the authors found that this exclusion lifted both the foreign and domestic investment of US multinationals.
7 https://econpapers.repec.org/bookchap/eeepubchp/3-20.htm
8 https://patrick-kennedy.github.io/files/TCJA_KDLM_2024.pdf
Tax revenue
The authors divide the tax revenue consequences of TCJA’s corporate reforms into two parts: the static revenue impact of the law’s provisions, holding the capital stock fixed; and the dynamic revenue effects of the changes in capital (and profits, wages, etc.) induced by the law.
The static revenue loss comes to about 41% of non-TCJA corporate tax revenue, or roughly $1.6 trillion over the first 10 years, broadly in line with other estimates. The dynamic response has several parts. The higher capital stock gradually lifts corporate tax revenue, gross of depreciation, but the persistence of higher depreciation deductions offsets much of this revenue increase, even out to 10 years. Personal income taxes rise due to the increase in wages and payouts to shareholders (a result of the higher capital stock and lower corporate tax rate), though much of the latter is offset by lower payouts to owners of pass-throughs (due to higher labor costs). All told, the dynamic revenue response offsets less than 2% of pre-TCJA corporate tax revenue through the first 10 years, though this does increase to about 20% further out. Still, on this reckoning, TCJA doesn’t pay for itself.
Bang for the buck
Decomposing TCJA’s corporate provisions by component, the researchers estimate that the cut in the tax rate accounts for the lion’s share of the revenue loss, though it also induces the biggest increase in capital. On a “bang for the buck” basis – i.e., loss of tax revenue per dollar of extra capital induced — the expensing provisions offer better value, though GILTI is the only major corporate component of TCJA estimated to raise revenue while also boosting domestic capital (because of the estimated complementarity between foreign and domestic capital).
A little something for everyone
This study is a cherry-picker’s delight. Proponents of TCJA will point to the powerful lift to domestic investment. Opponents will cite the smaller-than-advertised boost to wages and the muted dynamic impact on tax revenue. Both sides will struggle to conceal their normative biases. The fireworks are sure to intensify as the expiration deadline approaches.