Tax reform’s overarching purpose is to ensure a stronger economy for years to come. A useful approach to assessing the Tax Cuts and Jobs Act is to distinguish its tax cut from tax reform aspects. Both aspects are relevant from a certain perspective. Tax cuts were important first and foremost for giving middle-income American families relief after years of subpar income growth.
Tax cuts also helped create an environment conducive to tax reform, but tax cuts have not and will not materially contribute to the expected stronger long-term economic growth. Increasing the child tax credit has its merits, but doesn’t boost the economy.
The legislation included four key pro-growth provisions:
- Cutting all businesses tax rates – the top corporate rate to 21% and the effective pass-through business rate through a 20% deduction;
- Expensing for businesses capital purchases, thereby eliminating what was in effect a surtax on capital formation;
- Modernization of the U.S. international tax system to be competitive with the systems of our major trading partners; and
- Reduction in the estate tax burden.
Without doubt, these provisions’ benefits were blunted somewhat by other business tax reforms needed to reduce the net cost, but when all these effects are netted out the beneficial effects will remain profoundly positive.
That’s the story, but how will we know whether it holds true? To be sure, we will never know conclusively. Whether the economy slides into recession or goes on a 10-year run of historic growth, neither tax reform’s opponents nor defenders will be able to prove beyond a doubt whether tax reform made a difference. But, we can look for signs, even as early as the spring of 2018.
Signs of the tax cut can be found all over the economy. These included stories of companies providing bonuses and increased retirement contributions; stories of extra distributions to shareholders, whether through dividends or stock buybacks; and then the Internal Revenue Service adjusting tax withholding tables, giving workers a quick preview of their ongoing tax relief.
The U.S. Chamber has created a tax map to keep track of companies’ announcements following tax reform. While all of such announcements are welcome, they represent the tax relief aspect of the tax bill, not the tax reform aspect.
Tax reform will work in part by eliminating distortions across types of investment, improving horizontal efficiency. The tax code disadvantaged some investments more than others and the resulting distortions in investment patterns reduced economic performance.
But the biggest growth driver in tax reform arises from the cumulative effects of the provisions noted above as they work broadly to reduce the cost of capital on business investment. In short, the manifestation of tax reform working will appear when businesses start increasing their investments in new plant and equipment above what would have otherwise been the case, an effect the early hints of which we may already see but that will take time before it becomes really clear.
Businesses invest according to need or opportunity and according to plans. The change in the tax law must first be understood, then its effects will appear reflected in business plans. Only then can businesses respond fully to the new tax law by ramping up capital purchases. Happily, the initial signs of this additional investment may already be appearing in the form of rising new orders for manufactured durable goods.
The U.S. Census Bureau’s Manufacturers’ Shipments, Inventories, and Orders survey and report has long provided a window onto this sector of the U.S. economy. The survey provides a detailed look into “current industrial activity” and “current production commitments” by industry sector and by state of production from orders on through shipments. This survey will provide some of the first indications of businesses responding to the new tax law.
For context, new orders increased on average by about 0.5% a year from 2012 through 2016. New orders for durable equipment actually fell throughout 2015 and 2016, but by the start of 2017 new orders were back in solid plus territory. In its most recent report for April, the Census Bureau finds new orders for business equipment were up a hearty 6.9% year over year, and were up 8.6% for machinery. Some of this increase in durable equipment orders may be due to other factors, such as the ongoing effects from President Trump’s pro-growth regulatory policies and the increase in investment related to fracking following the recent increase in oil prices. But the rise in new orders for durable equipment is strong and widespread, suggesting tax reform’s effects are in play already.
In short, the great growth benefits from tax reform will begin with increasing business investment, the effects of which will then expand out into the economy in higher productivity, higher wages, more jobs, more output, more income, and more tax revenue at all levels of government. The primary effects of tax reform begin with business investment, and the early signs from the manufacturer’s survey suggest the business investment response will be as robust as advertised.