4 ways Trump’s tax cuts changed economy
Monday is the first Tax Day under the new rules of the Tax Cuts and Jobs Act, but Americans have been adapting to the law since it passed in late 2017.
Some of its effects are already visible, and some of them will take months, or even years, to understand. After all, economists are still publishing studies about the effect of the last comprehensive tax overhaul back in 1986, signed by Ronald Reagan.
Here’s what we can — and can’t — say about how President Donald Trump’s tax cuts have impacted the economy so far.
1. Corporate taxes fell off a cliff, fueling deeper deficits
One of the central features of the Tax Cuts and Jobs Act was a drop in the corporate income tax rate, from 35% to 21%.
Even though plenty of companies never paid that full rate because of various exemptions, the decrease still took a big bite out of corporate tax collections. They plunged from a seasonally-adjusted annual rate of $264 billion in the fourth quarter of 2017 to $149 billion the next, when the new rules went into effect, and they haven’t bounced back.
Corporate income taxes make up only a small slice of the federal government’s overall tax revenue, and have declined as a share of the economy from their post-World War II height in 1951. However, corporate tax revenue still tends to increase when the economy is doing well. This is the first time corporate taxes have taken such a hit when the economy is not in recession.
The nonpartisan Congressional Budget Office forecasts that corporate income tax revenues will gradually rise in the coming years, as will personal income taxes — but not enough for the tax cuts to “pay for themselves,” as their Republican backers claimed they would. According to the CBO, the tax overhaul is set to add $1.85 trillion to the national debt over an 11-year period, even accounting for positive macroeconomic effects.
Congress has yet to take up spending cuts to big-ticket items like Medicare and Social Security that the White House had proposed to curb deficits. Still, mounting debt makes conversations around future expenditures more difficult. Lawmakers have choked on passing a large infrastructure package, for example, because there’s no plan to pay for it.
“In some ways, our economy is held back by the public investments that we are not making,” said Steve Wamhoff, director of federal tax policy for the left-leaning Institute on Taxation and Economic Policy. “Even if we think that spending on infrastructure would be a good thing, politically we can’t do this spending because we have to address this deficit.”
2. A short-term economic boost is fading
Most economists forecast that the tax cuts, along with a boost to military spending, would goose the economy initially. The CBO estimates that about 0.3 percentage points of the 2.9% growth in gross domestic product in 2018 can be attributed to the tax cuts.
Part of that came from an increase in business investment in research and development, new factories and equipment, possibly encouraged by a provision that allowed businesses to immediately expense capital expenditures, rather than expense them gradually over several years. Business investment grew 8.4% from the fourth quarter of 2017 to the fourth quarter or 2018. That’s a good sign because better factories, equipment and tools are supposed to boost productivity, which in some cases allows workers to make more money.
Wages did start to grow a bit faster at the end of 2018, at least by some measures, especially for workers on the lower end of the income spectrum. But that was also a consequence of a tight labor market created by nearly a decade of continuous job growth, as well as minimum wage hikes in many states.
The White House’s Council of Economic Advisers used the growth surge in 2018 to trumpet the tax cuts as a success. The new lower corporate rate and temporary tax holiday on the repatriation of cash earned overseas, they argue, created a surge of investable capital — though companies returned a large chunk of it to investors in the form of share repurchases, mergers and acquisitions.
At the same time, they say the effects will take years to play out.
“We were the highest taxed place on earth. Now we are not,” said CEA Chair Kevin Hassett on CNN last week. “The adjustment to having all the industry come home is not something that happens overnight, it spreads out over three to five years.”
At the moment, though, trends are moving in the wrong direction. Business’ plans for capital expenditures have been declining for about a year now, according to an index maintained by Morgan Stanley. And aside from those who work for the White House, most economists — including those who work at the Federal Reserve and the International Monetary Fund — expect US economic growth to decline to about 2.1% to 2.3% in 2019.
Why? One possibility is that the boost in business investment may have had more to do with a rise in oil prices, which now drives a significant amount of domestic activity because of the US’ vast shale reserves, according to an analyst at the University of Pennsylvania’s Wharton School of Business.
The hurdle to investment in recent years has more to do with weak demand for goods rather than a shortage of capital, according to Kyle Pomerleau, chief economist at the right-leaning Tax Foundation.
“If you look at the US economy, it’s not lack of cash that’s keeping companies from investing,” Pomerleau said. “The whole issue is whether that cash can be deployed in a productive manner. Are there investments out there that result in a high enough after-tax return to be worthwhile?”
As evidence that there aren’t, most multinational companies haven’t fundamentally changed the complex tax structures that allow them to book profits overseas, according to an analysis by Council on Foreign Relations senior fellow Brad Setser.
Meanwhile, the White House has engaged in a trade war that makes raw materials like lumber and steel more expensive in the US, raising the cost of domestic production.
“You have two tax policies working against one another,” Pomerleau says.
3. Rich people gained more than poor people
About 66% of taxpayers saw their federal tax bill decline by more than $100 in 2018, the congressional Joint Committee on Taxation predicted the tax law would decrease charitable giving by $22 billion in 2018. Instead, an annual report from the Lilly Family School of Philanthropy at Indiana University projected above-trend growth in giving for 2019 and 2020, fueled by a healthy stock market and rising incomes.
However, the effect will be uneven. Lower-income filers will no longer benefit from the charitable deduction, which means the causes they favor may lose out.
“Larger institutions that depend on higher-income households may not feel the impact,” said Una Osili, who authored the Indiana University report. “But if you think about the causes that everyday givers support, like community based organizations, they see more of an impact.”
The impact that’s unseen
Most of the true impact of the Tax Cuts and Jobs Act is still yet to be felt. But one implication is already operating in the background. Tax cuts can help ease the impact of economic downturns, and now, there’s a lot less room to use them.
“The thing that’s related that I’m more concerned about is, we will eventually face another recession,” says Oh, of UCLA. “And what we’ve done through the Tax Cuts and Jobs Act is use a bunch of the tools that we need to deal with the next recession, at a time when we don’t have a recession.”