(What’s Left of) Our Economy: Could Trump’s Business Tax Cuts Be Working (Kind of) as Advertised?

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capex, capital spending, dividends, Factset.com, mergers and acquisitions, research and development, Standard & Poor's 500, stock buybacks, tax cuts, taxes, Trump, Washington Post, {What's Left of) Our Economy

One of the biggest stories in economics and politics over the past year has been the tax bill championed successfully by both the Trump administration and the Republican-controlled Congress. Economically it’s widely judged to have failed in its primary stated mission: encouraging more productive investment in the U.S. economy. And because it supposedly did little more than shower cash on already profit-rich corporations that overwhelmingly put it to supposedly unproductive uses like share buybacks and dividend payments (see, e.g., here and here), the American public rightly recognized it as a giveaway to tycoons and The Rich generally, and viewed it as one big reason to vote GOP candidates out of office in the recent midterm elections.

What a surprise, then, to come across evidence that the $1.5 trillion in business tax cuts so far have done a respectable job of working as advertised.

According to the Washington Post‘s Michael Heath, new research from Standard and Poor’s shows that since the tax package was passed, the firm’s well-known group of the 500 largest publicly traded U.S. companies have performed as follows:

>Through the first three quarters of this year, they’ve boosted share buybacks – which support the value of company stock and in the process enrich executives paid largely based on the increase (or decrease) in these stocks’ value – by 11.84 percent.

>During the same period, they’ve hiked capital spending (on new plant and equipment) by 19 percent.

>Over this span, they’ve boosted research and development spending by 34 percent.

>During the first eleven months of the year, their dividend payouts have been virtually unchanged.

When the entire American business universe is examined, the picture looks somewhat different – at least through the first half of this year. According to this summary of research from Goldman Sachs:

>buybacks rose 48 percent

>capital spending rose 19 percent

>research and development spending rose 14 percent.

What’s noteworthy about these figures, though, is that they indicate that the larger, indeed multinational U.S.-based companies spent their tax windfalls more productively than smaller, largely domestically focused firms. That’s noteworthy because one of the principal objectives of the tax cuts was to persuade the multinationals to stop stashing so much of their earnings abroad and bring these monies back home to stoke growth and jobs. So it appears that, to a significant extent, that’s what they’ve done.

Of course, the real results of the effects of the tax cuts (or any other policy initiative) can only be assessed accurately not simply by comparing year-on-year rates of change in various metrics, but examining how these rates of change have differed (if at all) from those of years before the initiative went into effect. I haven’t yet located the data for most of these indicators, but the chart below combined with the Washington Post figures for capital spending for the S&P 500 makes clear that it’s been growing much faster since the cuts were passed than before.

One area the Post didn’t look at, though, can’t be neglected: mergers and acquisitions. The numbers indicate that, measured by value, such activity increased much faster between 2017 and 2018 (for the first three quarters of the year) than between 2016 and 2017 – by 33.47 percent to 1.05 percent. (My sources are the 2016-18 data published by Factset.com.  Here’s its latest report.) The absolute numbers are sizable, too – the value of these transactions rose by more than $387.5 billion from January-through-September, 2017 to the same period this year. (Note: These figures are only authorized expenditures – but reportedly there’s evidence that 85 percent wind up getting made.)

But here (as elsewhere, for that matter) is where we run into a big complication that comes up whenever a policy initiative is judged: What changes are attributable to this move, and what changes to other factors? These other factors include other policies (like interest rate movements both announced and suggested by the Federal Reserve, or regulatory or trade policy changes), or existing or evolving business decisions on deploying capital (based on corporate judgments regarding likely customer demand that stem from the overall state of the economy or particular markets, and on how these situations are considered likely to change).

But all the same, a reasonable, defensible bottom line conclusion seems to be that productive business spending since the tax cuts’ passage is rising at a faster rate than before passage, and that the tax package has played a discernible role. Moreover, some of the other plausible reasons for this acceleration also are arguably attributable to Trump administration policies – at least in part.  Faster overall economic growth and regulatory reform are two examples. Trade policy might be a third.

Moreover, I’m making these points as someone who’s argued that President Trump’s prioritization of the tax cuts and Obamacare repeal was a major first-year mistakes, at least politically. Both should have taken a backseat to infrastructure building in particular. I’ve even expressed skepticism about the cuts’ likely economic impact.

But economically, the administration and its supporters seem to have had (and still have) a pretty good story to tell about the tax cuts – which could have bolstered their political appeal. Which means that a bigger mystery than the cuts’ actual effects could be why the administration told it so ineffectively.

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(What’s Left of) Our Economy: The Republican Tax Plans’ Biggest Flaw

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Alan Greenspan, Barack Obama, Bill Clinton, budget deficits, business spending, capital gains, corporate taxes, dividends, Federal Reserve, fiscal policy, George W. Bush, House, income taxes, monetary policy, multinationals, non-residential fixed investment, Paul Volcker, repatriation, Republican tax bills, Ronald Reagan, Senate, tax cuts, taxes, {What's Left of) Our Economy

The tax bills passed by the Republican-controlled House and Senate and strongly supported by President Trump (despite some important differences between them) can be fairly criticized for any number of big reasons: the mess of a drafting process in the Senate, the impact on already bloated federal budget deficits and the national debt, the cavalier treatment of healthcare reform, the seemingly cruel hits to graduate students and to teachers who buy some of their students’ school supplies.

My main concern is different, though. I could see an argument for the main thrust of the bills – even taking into account most of the above flaws – if they boasted the potential to achieve its most important stated aim. In Mr. Trump’s words, “We’re going to lower our tax rate to the very competitive number of 20 percent, as I said. And we’re going to create jobs and factories will be pouring into this country….” Put less Trump-ishly and more precisely, the idea is that by slashing tax rates for corporations and so-called pass-though entities, along with full-expensing of various types of capital investment, American businesses will build more factories, labs, and other productive facilities; buy more equipment, materials and software; hire more workers and increase their pay (since the demand for labor will soar).

Actually, since automation will surely keep steadily reducing the direct hiring generated by all this promised productive investment, let’s focus less on the jobs promise (keeping in mind that manufacturing in particular generates lots of indirect jobs per each direct hire), and more on the business spending that will boost output – since faster growth is the ultimate key to robust employment and wage levels going forward.

Unfortunately, after spending the last few days crunching some relevant numbers, I can’t see the GOP tax plans living up to their billing – which makes their flaws all the more damning.

What I’ve done, essentially, is look at inflation-adjusted business spending during American economic recoveries (to ensure apples-to-apples data by comparing similar stages of the business cycle) going back to the Reagan years of the 1980s, and examine whether or not individual and especially business tax cuts have set off a factory etc building spree. And I didn’t see anything of the kind, except possibly over the very short term. Moreover, even these increases may have had less to do with the tax cuts than with other influences on such investments – like the overall state of the economy and the monetary policies carried out by the Federal Reserve (which help determine the cost of credit).

Let’s start with the expansion that dominated former President Ronald Reagan’s two terms in office – lasting officially from the fourth quarter of 1982 through the second quarter of 1990 (by which time he had been succeeded by George H.W. Bush). The signature Reagan tax cuts, which focused on individuals, went into effect in August, 1981 – when a deep recession was still underway.

Interestingly, business investment kept falling dramatically through the middle of 1983 – when an even stronger rebound kicked in through the end of 1984. Indeed, that year, corporate spending (known officially as private non-residential fixed investment surged by 16.66 percent. But this growth rate then began slowing dramatically – and through 1987 actually dropped in absolute terms.

A major tax reform act was signed into law by the president in October, 1986, and individuals were its focus as well. Two provisions did affect business, but appeared to be at least somewhat offsetting in their effects, in line with the law’s overall aim of eliminating incentives and disincentives for specific kinds of economic activity. They were a reduction in the corporate rate and a repeal of the investment tax credit – whose objective was precisely to foster capital spending. Other provisions had major effects on business but principally by encouraging more companies to change over to so-called pass-through entities, not (at least directly) on investment levels. Business spending recovered, but its peak for the rest of the decade (5.67 percent of real GDP in 1989) never approached the earlier highs.

Arguably, fiscal and monetary policy were much more influential determinants of business spending, along with the recovery’s dynamics. The depth of the early 1980s recession practically ensured that the rebound would be strong, as did the massive swelling of federal budget deficits, which strengthened the economy’s overall demand levels, and their subsequent reduction.

Perhaps most important of all, the Federal Reserve under Chairman Paul Volcker cut interest rates dramatically from the stratospheric levels to which he drove them in order to tame double-digit inflation. And yet for most of 1984, when business spending soared, the federal funds rate (FFR) was rising steeply. Capex also strengthened between 1987 and mid-1989, which also witnessed a scary stock market crash (in October, 1987).

The story of the long 1990s expansion, which mainly unfolded during Bill Clinton’s presidency, was simultaneously simpler and more mysterious from the standpoint of business taxes – and macroeconomic policy. Following a shallow recession, Clinton raised both personal and corporate tax rates while government spending was so restrained that the big budget deficits he inherited actually turned into surpluses by the late-1990s. For good measure, the FFR began rising in late 1993, from 2.86 percent, and between early 1995 and mid-2000, stayed between just under six percent and just under 6.5 percent.

And what happened to capital spending? In late 1993, right after the tax-hiking, spending- cutting, deficit-shrinking Omnibus Budget Reconciliation Act was passed, and the Fed was tightening, businesses went on a capex spending spree began that saw such investment reach annual double-digit growth rates in 1997 and stay in that elevated neighborhood for the next three years.

It’s true that Clinton and the Republican-controlled Congress passed tax cut legislation in August, 1997, that among other measures lowered the capital gains rate. But the acceleration of business spending began years before that. And although we now know that much of this capital spending went to internet-centered technology hardware for which hardly any demand existed then at all, from a tax policy perspective, the key point is that this category of spending rose strongly – not whether the funds were spent wisely or not.

The expansion of the previous decade casts major doubt on whether any policy moves can significantly juice business spending. Just look at all the stimulative measures put into effect, tax-related and otherwise. The recovery lasted from the end of 2001 to the end of 2007, and during this period, on the tax front, former President George W. Bush in June, 2001 signed a bill featuring big cuts for individuals, and in May, 2003 legislation that sped up the phase-in of those personal cuts and added reductions in capital gains and dividends levies. For good measure, in October, 2004, the “Homeland Investment Act” became law. It aimed to use a tax “holiday” (i.e., a one-time dramatically slashed corporate rate) to bring back (i.e., “repatriate“) to the U.S. economy for productive investment hundreds of billions of dollars in profits earned by American companies from their overseas operations.

In addition, under Bush, the federal budget balance experienced its biggest peacetime deterioration on record, and starting in the fall of 2000, the Federal Reserve under Alan Greenspan cut the FFR to multi-decade peacetime lows, and didn’t begin raising until mid-2004.

The business investment results underwhelmed, to put it mildly. Such expenditures fell significantly throughout 2001 and 2002, and grew in real terms by only 1.88 percent the following year. Thereafter, their growth rate did quicken – to 5.20 percent rate in 2004, 6.98 percent in 2005, and 7.12 percent in 2006. But they never achieved the increases of the 1990s and by 2007, that expansion’s final year, business investment growth had slowed to 5.91 percent.

There’s no doubt that something needs to be done to boost business spending nowadays, which has lagged for most of the current recovery and turned negative last year – even though the federal funds rate remained near zero for most of that time and the Federal Reserve’s resort to unconventional stimulus measures like quantitative easing as well, despite unprecedented budget deficits (though they began shrinking dramatically in 2013), and despite the continuation of all the Bush tax cuts (except the repatriation holiday, and the imposition of a small surcharge on all investment income to help pay for Obamacare). Business investment’s record during the current recovery has been even less impressive considering a Great Recession collapse that was the worst in U.S. history going back to the early 1940s, and that should have generated a robust bounceback.

But if history seems to teach that tax cuts and even other macroeconomic stimulus policies haven’t been the answer, what is? Two possibilities seem well worth exploring. First, place productive investment conditions on any tax cuts and repatriation (the 2004 tax holiday act did contain them) and then actually monitor and enforce them (an imperative the Bush administration neglected). And second, put into effect some measures that can boost incomes in some sustainable way – and thus convince business that new, financially healthy customers will emerge for the new output from their new facilities. To me, that means focusing less on ideas like raising the national minimum wage to $15 per hour (though the rate should, at long last, be linked to inflation), and more on ideas like trade policies that require business to make their products in the United States if they want to sell to Americans, and immigration policies that tighten labor markets and force companies to start competing more vigorously for available workers by offering higher pay.

In that latter vein, the 20 percent excise tax on multinational supply chains contained until recently in the House Republican tax plan could have made a big, positive difference. Sadly, it looks like it’s been watered down to the point of uselessness, and the original has little support in the Senate. The House Republican tax plan also had included a border adjustment tax that would have amounted to an across-the-board tariff on U.S. imports (and a comparable subsidy for American exports), but the provision was removed from the legislation partly due to (puzzling) Trump administration opposition.

Mr. Trump clearly has acted more forcefully to relieve immigration-related wage pressures on the U.S. workforce, but it’s unclear how quickly they’ll translate into faster growing pay.  If such results don’t appear soon, and barring Trump trade breakthroughs, expect opponents of the Republican tax plan to keep insisting that it’s simply a budget-busting giveaway to the rich, and expect these attacks to keep resonating as the off-year 2018 elections approach.