ECONOMICS Bloomberg Businessweek March 11, 201931ILLUSTRATION BY CHARLOTTE POLLET. DATA: BUREAU OF ECONOMIC ANALYSIS; BLOOMBERG ANALYSIS OF BEA AND INTERNAL REVENUE SERVICE DATA
THE BOTTOM LINE An analysis by Bloomberg Economics shows
that tax rates aren’t as important a factor in corporate investment
as supply-siders make out.The Devil Is in the Deductions
Effective tax rate Top marginal tax rate1950 201860%300More Than a Casual Relationship
Investment growth Corporate profit growth1981 201830%150-1 5The chart below suggests that higher profits do
in fact lead to more investment. Capital spending
rose 7 percent in 2018 after climbing a little more
than 5 percent the previous year. But how much of
that was in response to the tax cuts?
To adequately assess the impact of tax reform
on investment, it’s important to look beyond the
much-touted drop in the top marginal tax rate and
consider other important changes to the corporate
tax code, such as allowing businesses to immedi-
ately write off certain capital expenditures in full
and limiting the deduction for business interest
expenses. The effective tax rate, or the amount
of tax paid divided by corporate profits, gives a
more complete picture of a corporation’s tax lia-
bility. Note in the chart to the right that despite a
sequence of tax changes in the 1980s, the effec-
tive rate was higher at the end of the decade.
President Ronald Reagan’s Tax Reform Act of 1986
did lower the top marginal rate but barely moved
the effective rate.
While both of these rates have been trend-
ing lower for decades, the TCJA pushed them to
their lowest levels since at least the 1950s. The lat-
est round of tax reform lowered the effective rate
from about 16 percent in 2017 to about 10.5 percent
last year (again, the calculation is based on the first
three quarters of 2018).
Bloomberg Economics estimates the 5.5 per-
centage point drop in the rate led to a 1percent
boost to nonresidential investment, which added
a tenth of a percentage point to gross domestic
product in 2018. So without the corporate side of
the TCJA, growth last year would have been 3 per-
cent instead of 3.1 percent. That’s a much smaller
boost than what White House officials had prom-
ised. In the months leading up to passage of the
TCJA, Kevin Hassett, the chairman of the Council of
Economic Advisers, estimated that the effect from
a package of tax measures similar to those in the
legislation would be “much more than 1 percent.”
So if tax cuts don’t have a large impact oninvestment decisions, what does? Our review of
data going back to 1950 considered a host of vari-
ables related to investment, including the output
gap, business confidence, capital depreciation,
and interest rates. It showed that business con-
fidence, or what John Maynard Keynes liked to
call “animal spirits,” along with the basic laws of
supply and demand, are more important drivers
of investment.
Improving confidence and diminishing eco-
nomic slack—approximated by the output gap, a
measure that tracks how economic activity is per-
forming relative to its potential—aren’t only better
indicators of where investment is headed, but also
have an effect magnitudes larger than that of tax
cuts. The reason is simple. Businesses will expand
production capabilities when they feel optimistic
about their future prospects and when existing
capacity can’t meet demand for their products.
Reducing their corporate tax burden strengthens
incentives to invest if other factors are in place. On
its own, though, it doesn’t move the dial.
There’s little question the country’s corporate
tax code was in need of reform. The U.S. was a
comparatively more expensive place to do busi-
ness, which motivated companies to locate oper-
ations offshore (though the TCJA may end up
exacerbating that trend as income from subsid-
iaries abroad will have a tax rate roughly half that
of domestic income).
While the TCJA hasn’t quite lived up to the
supply-side sales pitch from a growth perspec-
tive, its effects on government finances have
been broadly in line with what its detractors
anticipated. Federal tax receipts from corpora-
tions plummeted almost 31 percent in the calen-
dar year—the sharpest decline on record (the data
only go back to 1982), save for the second year of
the Great Recession. —Tim Mahedy