In 2018, provisions of the 2017 Tax Cut and Jobs Act went into effect. The Act simplified some aspects of the federal tax code and restructured tax rates with the purported goal of enhancing economic growth.
In particular, the Act reduced the U.S. corporate tax rate from 35 percent to 21 percent. For US companies, which have historically faced some of the highest levies of any developed nation, the reduction strengthened competitiveness in global markets. The hope was that the Act would also encourage additional capital investment.
For much of the past year, capital expenditures by U.S. firms were at levels not seen in decades. While many predictably used funds for other purposes (such as stock buybacks), total investment was unmistakably and notably higher. First quarter 2018 spending by the companies in the S&P 500 was up about 20 percent from a year prior, the largest gain since 2011. Much of this increase was in the burgeoning energy sector and would likely have happened irrespective of the tax changes.
It is difficult to separate the portion of these increases that was attributable to the tax cut. Corporate investment and hiring decisions are based on many criteria, including expectations for growth and risk. Even if there were no taxes, companies would not spend money for new plants or equipment or staff without a business justification. Tax policy affects competitiveness and investment levels, but it’s only one determinant at the margin.
Recently, a survey by the National Association for Business Economics (NABE) made headlines with 84 percent of respondents indicating that tax policy hadn’t affected capital expenditure or hiring decisions, which suggests that large outlays by a few companies were quite impactful. The survey was also somewhat limited in scope and timing. Lower tax rates did seem to affect the goods-producing sectors according to the NABE, with 50 percent of respondents reporting increased investments at their companies and 20 percent noting redirected hiring and investments to the U.S. from abroad.
While it is important to keep federal finances on a sustainable path and the new law exacerbated already massive deficit challenges, lower taxes for US businesses are a way to improve global competitiveness. Even with the lower corporate tax rate, U.S. companies still have higher rates than most trading partners, particularly when state levies are considered. However, it is important to separate out the effects of tax cuts from other things going on in the economy (such as the current energy revolution). While tax consequences were certainly taken into account, companies invested due to strong growth and optimism. As a result, it is not surprising that capital spending is now slowing as uncertainty about numerous global phenomena escalates. Stay tuned!!