The Tax Cuts and Jobs Act in Year One

By Tracy C. Miller of Mercatus. Excerpt:

"With Tax Day just behind us, it’s a good time to reflect on our first full year under the Tax Cut and Jobs Act (TCJA), which President Trump signed in December 2017. In many ways, 2018 was a banner year. The economy grew by 2.9 percent, unemployment fell to 3.7 percent and wages grew by 3.4 percent. Some of the good economic news seems to be associated with the TCJA, and particularly the law’s reduction of the corporate income tax rate and changes to depreciation allowances.

Up to this point, the evidence on the impact of the TCJA on investment, labor productivity, employment and economic growth is only suggestive. Each had been rising due to the economic recovery. But there are good reasons, based on economic theory, to suggest that part of the growth during 2018 is related.

Proponents of the tax reforms projected they would increase investment, which would result in raising household income. The reforms lowered the percentage of each corporate dollar earned that will be taxed, giving firms an incentive to invest in a wider array of projects, including some with slightly lower pre-tax rates of return. In other words, lower taxes make more projects worth investing in.

As firms increase their investment in capital, workers have more capital to work with. Workers become more productive, firm output and revenues rise, and firms can afford to pay their workers more. And sure enough, due to lower taxes on corporate profits and expected increases in capital investment, workers were able to bargain for wage increases.

Critics emphasize that corporations used much of their tax savings for stock buybacks, where firms purchase existing stock from their shareholders, which primarily benefits those wealthy shareholders. However, the most important and long-lasting benefit of last year’s corporate tax changes are the incentives they give firms to invest more money in domestic operations. In addition to the benefits of investment for workers, shareholders expect to gain more after-tax income.

The results of the TCJA were consistent with proponents’ expectations based on economic models. During 2018, investment rose by 0.5 percent of GDP — with business investment rising faster than residential investment—while consumption spending fell by 0.3 percent of GDP. People consume less and save and invest more when the rewards for investing — higher after-tax profits — increase."