Cut Corporate Taxes to Boost Investment and Wages?

Reports suggest that the US Congress is making progress toward tax
reform. 
The House of Representatives is still slated to vote on its
version tomorrow.  It appears likely to pass.  The Senate version
will be marked up in committee this week.  The latest revisions include
repealing the individual insurance mandate and ending the middle class and
small business tax break after 10 years
to reduce the long-term costs while keeping the corporate tax cut permanent.
  

Many proponents of the proposals make it seem that a corporate tax cut is
a panacea for all that ails the US
.  It will boost investment, which
in turn will boost productivity.  It will boost wages, which in turn will
boost aggregate demand and inflation. 

Why would anyone in their right mind object?   The simple answer
is history.  In the recent history of tax changes, there is not much
evidence that a corporate tax cut boosts investment or wages.  The
“trickle down” economics, which the Chair of the National Economic
Council, specifically called the current proposals, used to be an
epithet.  It was a note of derision,
and yet in a surreal and Orwellian way, it was used to defend and justify it.  

Reports suggest at yesterday’s WSJ CEO Council, Cohn, the Chairman of the
National Economic Council was surprised that not more corporates planned on
increasing investment if the tax reforms were
implemented.
  There is a good reason not to be surprised.  First,
corporations have reported record profits.  The lack of investment is not
due to the lack of funds.  

Second, businesses have been saying to whoever
will listen that it does not plan to invest a windfall from lower taxes.
 
A large US bank surveyed its 300 + corporate clients over the summer and found
the that paying down debt was going to be their chief use of funds freed up by
lower taxes. After paying down debt, share buybacks and acquisitions were most frequently cited.  New
investment and R&D was toward the bottom of the
priorities.    This is
consistent with what businesses actually
did after 2004 Homeland Investment Act, which
dramatically cut taxes on repatriated earnings.  

Surely, allowing companies to write off the cost of new investment in
plant and equipment for the next five years will boost investment. 
Not
really.  It assumes that there is some pent-up
need that is not being met. Tomorrow, the
US reports capacity utilization figures.   In September, US factories
were using a little more than 3/4 of
their capacity.  It has averaged 76.2% this year and 75.7% last year, and
that is with growth the Fed says is somewhat above trend.  The peak since
the 2009 trough was in 2014 a little above 79%.  Past cyclical peaks were
above 80%.  

The reason that business investment is low and wage pressures are modest
is not because businesses lack funds.
  The reason is that business doesn’t have to increase such
expenditures.  To the extent, some
businesses are experiencing a that a shortage of some skilled and unskilled
workers (as seen in the Beige Book) wages have in fact edged
higher.  

Some proponents of the corporate tax cut argue
that the fewer businesses are paying to
the Internal Revenue Service, the more money is available for wages.  

The assertion that a corporate tax cut to 20%
will boost typical household income by $3-$7k has been refuted by many
economists, but it also does not pass the smell test.  An online
poll conducted for the NY Times found 78% of the respondents did not expect
that they would receive a raise if their employer got a tax
cut.   

To be sure, this is not a partisan claim.  The survey found 70%
of self-identified Republicans and 65% who said they strongly approve President
Trump’s performance recognized that corporate tax cuts are unlikely to trickle
down to higher wages.  

There may be other reasons that some may support the corporate tax cuts,
but spurring investment and wage growth are not compelling or convincing
arguments.
  The kind of investment that may be more necessary,
and can boost wages and productivity is public investment, but the tax reform
proposals will leave little room for an infrastructure initiative. 

Although the equity market advance appears to be largely explained by rising earnings, some expectation for tax cuts may have also lent support.  During period of Fed tightening, it is not unusual for the yield curve to flatten.   Tax  reform could help counter the flattening, but with around $11 trillion of negative yielding debt (in Europe and Asia), and the US the only major center that the supply of new bonds will outstrip the demand from the central bank, the demand for the long-end of the curve may not slacken much, while the short-end is anchored by Fed expectations.    

 

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