Parsing the TCJA's Impact

As we quickly approach the second anniversary of the signing of the Tax Cuts and Jobs Act (TCJA), retrospectives are trying to judge whether the tax reform package was a success. Yesterday’s The New York Times published the most recent, looking at FedEx’s tax liability and whether the company’s investments increased. The piece is worth a read, but it misses the mark in its economic analysis. 

Many economists, including me, predicted that the TCJA would boost business investment. The insight is a relatively simple one. Businesses undertake investments that are profitable to them. The business adds up all the additional revenue projected from the investment and compares it to the costs of the investment. Taxes are just one of the many costs of a particular investment, such as a new machine. If the revenues exceed the costs, the business will make the investment. 

As else being equal, lowering the corporate tax rate from 35 percent to 21 percent will make more investments profitable. Allowing businesses to immediately deduct the costs of investments further reduces the tax bite of any investment. As a result, more investments become profitable, increasing total investment. 

Now, this shouldn’t be understood to mean that all investments are profitable. Even if the corporate income tax was fully eliminated, there would still be unprofitable investments. Business costs include more than just taxes. 

In The New York Times piece, the authors compare business investment to the size of the tax cut each company received. But we wouldn’t expect those two things to be directly related. Cutting the corporate tax rate also cuts the tax rate on old investments. So the investments the company had already made at the 35 percent are now extra-profitable, giving the company a windfall of cash. It isn’t the windfall that drives investment, it’s the cost-benefit analysis described above. 

Rewarding FedEx for much of its prior investment explains the company’s stock buybacks. The newfound cash needed a use. The company would first undertake any profitable investments, but if there were not any profitable investments left, returning it to the shareholders in a one-time stock buyback is a reasonable approach. 

It’s also quite possible that the new investments spurred by the TCJA didn’t happen at established companies like FedEx. Rather, they may happen at new companies that we don’t even know. In fact, it’s possible that some of the capital returned to shareholders via the stock buyback could have become capital for new companies looking to expand their investments. 

To truly know if the TCJA spurred investment, we actually need to construct a counterfactual. We need to imagine what the U.S. economy would have looked like without the TCJA in order to properly compare it to the world as we know it.

It’s important to note that this sort of analysis is challenging. Taking guesses about what might have occurred with different tax policy is inherently difficult and since the TCJA passed, the economy has changed a great deal. The president’s trade war has discouraged investments, and increases in government spending have economic impacts too. Things have changed a lot in two years.

In some ways, it’s still too early to know. If you believe that cutting the corporate tax rate spurs investments--like I do--patience is needed. It takes several years for companies to plan their investments, to permit it, to purchase it, to put it in place, and to reap the rewards of increased productivity. It doesn’t happen overnight. It takes a series of nights, over many years. 

As we approach the second anniversary of the TCJA, much will be made of its impact on the economy. But those reviews need to remember the story of how companies invest, growing the economy.