Searching for Supply-Side Effects of The Tax Cuts and Jobs Act
The 2017 Tax Cut and Jobs Act (TCJA) was built on the idea that lower business and corporate tax rates, new domestic investment incentives, and guardrails against international profit shifting would increase investment, make workers more productive, and ultimately raise output and wages.
Did it work? In a new paper with my Tax Policy Center colleague Claire Haldeman, we conclude that, consistent with these goals, TCJA reduced marginal effective tax rates (METRs) on new investment and reduced the differences in METRs across asset types, financing methods, and organizational forms.
But it had little impact on business investment through 2019 (where we stopped the analysis, to avoid confounding TCJA effects with those of the COVID-related shutdowns that ensued). Investment growth increased after 2017, but several factors suggest that this was not a reaction to the TCJA’s changes in effective tax rates.
First, the timing of the investment response was not consistent with a supply-side response. Much of the investment increase was concentrated in oil and related industries and appeared to be a response to oil price increases, not lower tax rates. Indeed, other investment did not grow very much, and even overall investment growth petered out by the end of 2019.
Investment growth across asset types such as equipment, structures, and intellectual property did not correlate with the law’s changes in METRs. The types of capital that saw the biggest cuts in tax rates also saw the smallest increases in investment.
In addition, the growth rate of business formation did not rise post-TCJA, and surveys suggest that only a small minority of businesses made TCJA-induced investments. Growth of employment and median wages slowed in 2018 and 2019 relative to the pre-TCJA years of 2016 and 2017.
The much-vaunted bonuses that some firms provided employees at the end of 2017 were tiny relative to wages. And they appear to have been motivated mainly by political considerations – or by the opportunity for firms to accelerate pay into 2017, when costs could be deducted against a 35% corporate tax rate, rather than 2018, when the deduction was worth only 21 cents on the dollar.
The impact of TCJA on GDP growth is more difficult to pin down. The economy did grow faster after 2017 than had been predicted before TCJA, but many other factors also affected the economy between 2017 and 2019.
Despite the ardent claims of its advocates, TCJA significantly reduced federal revenue relative to what would have been generated had the law not passed. That is, it never came close to achieving the Laffer Curve promise that supply-side tax cuts would generate so much economic growth that they would increase tax revenues.
Despite the substantial reduction in the corporate tax rate and the new provisions that target cross-country tax avoidance, TCJA reduced international profit shifting only modestly. And it had little effect on efforts of US firms to reduce their US tax liability by being acquired by a firm headquartered in a lower-tax country.
The TCJA provision that allowed firms to return overseas profits to the US without paying US tax created a one-time spike in repatriated funds. This generated a wave of corporate stock repurchases but, as noted above, there seems to have been little impact on investment or wage growth.
Our study comes with several caveats. First, it is not always easy to establish a compelling story of what the economy would have looked like absent the TCJA. This is particularly true for GDP growth, where the supply-side effects of TCJA were confounded by the increase in disposable income TCJA created and by contemporaneous changes in oil prices and monetary and fiscal policy. President Trump’s aggressive tariffs made it especially difficult to tease out the effects of the TCJA.
Second, by analyzing results only through 2019, we focused only on short-term effects, which may be a poor guide to the long run. Short-term growth dynamics typically are dominated by changes in aggregate demand while long-term growth stems from changes in supply.
Both experts and advocates emphasize that the supply-side process may take a significant amount of time to take full effect.
Overall, the TCJA’s advocates promised many supply-side benefits and promised they would materialize quickly. But at least for the first two years, the Act failed to deliver its promises on investment and growth, leaving the country instead with higher deficits and a less equal distribution of after-tax income.