‘Not much’: What macroeconomic data say about the impact of the Tax Cuts and Jobs Act
This blog post is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to see all of the blogs in the #TCJANowWhat series.
What does macroeconomic data since the passage of the Tax Cuts and Jobs Act of 2017 (TCJA) tell us about its impact on business investment and thus the future growth of the US economy? Not much.
The first sense in which the data tell us “not much” is quite literal. The TCJA does not appear to have had nearly as much impact as many of its biggest cheerleaders expected and thought they saw in the data in the initial months after it passed. We now have six quarters of data since the law passed, and gross domestic product (GDP) has grown at an annualized rate of 2.5 percent in that period. That is a slight slowdown from the 2.6 percent annual rate in the six quarters leading up to the law’s passage, as shown in the chart below. This reflects the slowdown across consumption, business investment, and residential investment—which was only partly offset by the increase in government spending.
A closer look at investment shows how complicated the overall story is—and just how large forces other than the TCJA are relative to the tax law itself. As the table below shows, overall business investment slowed, but the components tell widely varying sectoral stories. The largest sectoral factor is the sharp slowdown of investment in oil and mining equipment and structures, which has returned to a more normal growth rate (3.9 percent) after the oil price increase fueled an annual growth rate of 37 percent in the six quarters preceding TCJA passage. Looking just at equipment and structures excluding the volatile oil and mining category still shows a decline in the rate of investment.
Another sectoral factor helping aggregate business investment growth has been the rapid growth in software and the substantial pickup in investment in research and development. This too is a sectoral story about the changing business use of technology in the economy and has nothing to do with the TCJA, which actually raised effective tax rates on many of these investments. (Research and development was previously expensed, so the main impact of the reform’s rate reduction was to reduce the value of interest deduction.)
In addition to these specific factors and trends affecting individual components of investment, three other macro factors have also affected overall investment in offsetting ways. The first was the fiscal stimulus associated with the tax cuts and spending increases passed in February 2018. The combined effect of these measures temporarily boosted growth by about ¾ of a percentage point. The second was a tightening of monetary policy, which could have reduced growth by about ¼ of a percentage point. The third was the escalation of tariffs against China and the rise generally in trade tensions, which a range of analysts put as subtracting around ¼ of a percentage point over this period (although the effects could grow in the future as tariffs have expanded). All three of these factors would affect investment in different ways, but overall it is reasonable to expect that they roughly cancel out.
Congressional Research Service and Penn-Wharton Budget Model analyses reach a similar conclusion: There is little reason to believe the TCJA substantially boosted investment to date and also that, to the degree that some components of investment initially rose, it was more due to rising oil prices than changing tax laws. The macroeconomic data also tell us not much in a second sense: Even if we could extract the signal from the noise, it is too early to tell whether the law is living up to its goal of increasing business investment and capital stock over the medium and long run. Relative to what we have seen to date, the long-run impact could be smaller (if recent investment was fueled by temporary fiscal stimulus that fades away) or larger (if the cumulative impact on the capital stock takes time to grow).
In the face of this view of not much, I see little reason to update the ex ante estimates of the law’s impact on investment and growth based on standard economic relationships, such as how it changed the cost of capital for business investment and the resulting effects on business investment. There was a remarkable uniformity in these estimates by all nonpartisan forecasters in academia, investment banks, and the public sector. My own estimates, in a paper with Robert Barro, were that the tax law would increase the long-run capital-labor ratio in the corporate sector by 7 percent while decreasing it by 2 percent for pass-through businesses. After 10 years, this translates to an increase in real GDP growth rate of 0.04 percent per year, a change that would be difficult to detect amid noise and other factors. As I have written elsewhere, the effect on national income, accounting for increased foreign borrowing and depreciation, would be even smaller.
One day, maybe, we will have a basis to update these projections, but if we do, it will likely be economists working with firm-level data who exploit variations in how different firms were treated by the law to more precisely infer its impact. Until then, we can just grasp at the wisps of macro data at hand to assess the law’s impact.
Going forward, we should all agree that we need a tax code that is more stable and efficient. In some ways, this would build on the TCJA reform by expanding, expensing, and making it permanent and further limiting interest deductions. In other ways, it would involve partially undoing the TCJA, by raising the corporate rate to around 28 percent. Together you could call this tax reform or even repeal and replace. A realistic assessment of the TCJA’s consequences can help inform this important debate.
Jason Furman is Professor of the Practice of Economic Policy at Harvard University’s Kennedy School of Government and a nonresident senior fellow at the Peterson Institute for International Economics.