The GOP Tax Plan Was Sold On a Baseless Theory. Now It’s Being Exposed As a Giveaway to the Rich.

Josh Bivens and Hunter Blair April 17, 2018

Economic theory doesn’t support claims made by supporters of the GOP tax plan. (Photo by Chip Somodevilla/Getty Images)

On Tax Day, Repub­li­cans in Con­gress will sure­ly be try­ing to tout the ben­e­fits from the Tax Cuts and Jobs Act (TCJA) that they passed in Decem­ber. It’s still far too ear­ly to make big claims about what the data shows about the effect of the TCJA, but it’s worth remem­ber­ing why we should be very doubt­ful that any ben­e­fits at all will accrue to typ­i­cal Amer­i­can fam­i­lies from the largest — and only per­ma­nent — fea­ture of the TCJA, the cuts in cor­po­rate income tax rates.

The TCJA’s like­ly effect on the econ­o­my depends on whether the econ­o­my remains demand-con­strained or not. Below, we’ll lay out why the TCJA is bad pol­i­cy regard­less of whether or not today’s econ­o­my remains demand-constrained.

When the econ­o­my is demand-con­strained, there is not enough over­all spend­ing in the econ­o­my — or aggre­gate demand” — to pin the econ­o­my at full employ­ment. If the econ­o­my still suf­fers from a lack of aggre­gate demand, as we believe is like­ly the case, then tax cuts can boost demand — and there­by employ­ment — by increas­ing the post-tax income of house­holds and businesses.

The TCJA is gen­er­al­ly not defend­ed on the grounds that it will boost demand. The rea­son why is clear: the tax cuts that make up the bulk of the TCJA — tax cuts for the rich and big cor­po­ra­tions — are by far the weak­est fis­cal stim­u­lus to aggre­gate demand. High-income house­holds are more like­ly to save the mon­ey they receive from a tax cut than low- and mod­er­ate-income house­holds. This means that much of the TCJA will end up as sav­ings in the pock­ets of rich house­holds rather than a boost to aggre­gate demand. Cor­po­rate tax cuts don’t rate any bet­ter on this core, for the same rea­sons. In the short run, the ben­e­fits of cor­po­rate tax cuts flow to share­hold­ers. The top 1 per­cent owns 40 per­cent of total stocks. In short, cor­po­rate rate cuts are sim­ply tax cuts for the rich by anoth­er name. Tax cuts for low- and mid­dle-income house­holds would have pro­vid­ed about three times as much bang for the buck as the TCJAs tax cuts for the rich and big cor­po­ra­tions, as would have increas­es to income sup­port pro­grams or infra­struc­ture spending.

All of this is why defense of the TCJA (and tax cuts for rich peo­ple gen­er­al­ly) assumes the econ­o­my is not demand-con­strained and is already at full employ­ment. In this case, the claim is that cuts to the cor­po­rate rate give com­pa­nies high­er after-tax prof­its with which they can pay div­i­dends to share­hold­ers. This increas­es cor­po­ra­tions’ incen­tive to under­take invest­ment in new plant and equip­ment. And because the increase in the post-tax return to cap­i­tal own­ers’ sav­ings induces house­holds to save more (or attracts more sav­ings from abroad), these desired new invest­ments can be financed with­out being choked off by ris­ing inter­est rates. The result­ing increase in cap­i­tal invest­ment gives work­ers more and bet­ter tools to work with, which boosts labor pro­duc­tiv­i­ty and even­tu­al­ly wages.

This all makes sense in the­o­ry, but as we’ve long detailed, the real-world evi­dence doesn’t sup­port that cuts to cor­po­rate income tax­es will help typ­i­cal Amer­i­can fam­i­lies. The rea­son for this in today’s econ­o­my is sim­ple: post-tax returns to cap­i­tal invest­ment have been at his­toric highs for years now, yet cap­i­tal invest­ment lags. Increas­ing post-tax returns just does not seem to loosen any seri­ous con­straint on eco­nom­ic growth.

Even worse for the TCJA, how­ev­er, is that the pre­vi­ous analy­sis assumes that these tax cuts to cor­po­rate income tax rates were paid for and do not add to the fed­er­al bud­get deficit. But as we all know now, the TCJA was not paid for. Accord­ing to the Con­gres­sion­al Bud­get Office, the TCJA will add almost $1.9 tril­lion to deficits over 10 years. In the pre­vi­ous analy­sis, the boost to post-tax prof­it rates increased the incen­tive for pri­vate house­holds to save, and this allowed new invest­ments to be financed with­out push­ing up inter­est rates. But for this to be true, it isn’t enough that just pri­vate sav­ings increase — over­all nation­al sav­ings must increase to keep inter­est rates from ris­ing in the face of high­er invest­ment demand. The increase in fed­er­al bud­get deficits caused by the TCJA reduces pub­lic sav­ings, and this would off­set the effects of increased pri­vate sav­ings. This means that if the econ­o­my gen­uine­ly is at full employ­ment (as most TCJA pro­po­nents claim), then its fail­ure to pay for the tax cuts will lead to high­er inter­est rates that will choke off any invest­ment incen­tive the TCJA provides.

There is sim­ply no way to make a case that the TCJA was good eco­nom­ics rel­a­tive to any plau­si­ble alter­na­tive. It has exceed­ing­ly low bang for the buck as a stim­u­lus mea­sure. Tax cuts that went dis­pro­por­tion­ate­ly to low- and mid­dle- income house­holds, instead of to the rich and big cor­po­ra­tions, or increas­es in gov­ern­ment spend­ing would have stim­u­lat­ed the econ­o­my by about three to five times as much. And once the econ­o­my is at full employ­ment, any the­o­ret­i­cal ben­e­fit that could have come from cut­ting cor­po­rate tax rates will like­ly be off­set by the increased deficits caused by the TCJA.

This should make clear that eco­nom­ic the­o­ry doesn’t sup­port claims made by sup­port­ers of the TCJA. As an exam­ple, since in the short-run the ben­e­fits of cor­po­rate rate cuts flow entire­ly to share­hold­ers, recent cor­po­rate PR stunts cen­tered on employ­ee bonus­es have noth­ing eco­nom­i­cal­ly to do with the TCJA. Instead, as the the­o­ry shows, an eco­nom­ic defense of the TCJA must rest on cap­i­tal investment.

Again, in the­o­ry the increased deficits caused by the TCJA will off­set the ben­e­fits that cor­po­rate rate cuts could have had on invest­ment. But teas­ing out the effect the TCJA has had on cap­i­tal invest­ment in prac­tice is going to take more time, and more data. Ear­ly reviews were not inspir­ing as orders for non­de­fense cap­i­tal goods fell in both Decem­ber and Jan­u­ary. March orders at least moved in the right direc­tion for the tax cut’s pro­po­nents, but still don’t show any change in trend growth. Around the end of April, we’ll get a first pass at some quar­ter­ly data to start see­ing what, if any, effect the TCJA is hav­ing on invest­ment and oth­er eco­nom­ic data. But even this will be ten­ta­tive, and in the mean­time there is no rea­son to think that the effects of the TCJA in prac­tice will dif­fer from what the­o­ry predicts.

This piece orig­i­nal­ly appeared at the Eco­nom­ic Pol­i­cy Insti­tute blog. 

Josh Bivens is the direc­tor of research at the Eco­nom­ic Pol­i­cy Insti­tute (EPI). Hunter Blair joined EPI in 2016 as a bud­get ana­lyst, in which capac­i­ty he research­es tax, bud­get, and infra­struc­ture policy.
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