Republicans in Congress say cutting corporate taxes would improve the balance sheet for U.S. businesses, giving them more money to spend on jobs and investment.
But how does anyone know that’s what will happen?
It’s the question at the heart of the debate taking place on Capitol Hill right now about whether to lower corporate taxes, and by how much.
U.S. corporations pay an effective tax rate of 35 percent, although most manage to lower that through various loopholes, exemptions and tax credits. The GOP plan would reduce the effective rate to 20 percent, bringing it more in line with other advanced economies.
To hear President Trump and other Republicans describe it, such a cut would be the magic elixir the U.S. economy has been needing.
With their taxes cut, businesses would have more money to spend. Companies such as Apple could bring back some of the billions of dollars they’ve stashed overseas. And with more money on their balance sheets, they could hire more and invest in factories and equipment.
“When our businesses pay less in taxes, they reinvest that money into their companies. They create new jobs. They save and secure jobs that exist. They start paying more in benefits and different benefits, and they invest in inventory,” said Kellyanne Conway, White House counsel, speaking on Fox News last week.
When companies invest more in plants and equipment, they become more productive, which leads to higher wages, even for low-skilled workers, according to a recent report from the White House Council of Economic Advisers.
How much would wages increase? The report predicted that cutting corporate taxes would raise annual household incomes $4,000, on average, and probably even more than that.
Economist Kimberly Clausing of Reed College says on the surface the logic sounds airtight.
“The principle makes a lot of sense, the thought that you increase investment and that investment increases the productivity of your workers and then your workers get paid more in consequence,” says Clausing.
But Clausing says the reality is a lot more complicated.
“There’s no evidence that corporate tax cuts unleash a big wave of economic growth or wage increases,” she says.
Clausing says predicting the impact of corporate tax changes on growth is notoriously difficult, because an economy the size of the United States simply has too many moving parts. A surge in growth could be due to tax cuts, or it may be something else entirely.
“The trouble is, we really don’t have a good way to measure what the effects on growth are, because once we have the rate cut, other things start happening over time,” says Jennifer Blouin, professor of accounting at the University of Pennsylvania’s Wharton School of Business.
“If I go ahead and cut tax rates this year, do I just look at how much [Gross Domestic Product] or hiring or capital expenditures increase next year, or do I look two years or five years or the next 10-year budget cycle?” Blouin says.
“Well, other things happen. We have natural disasters. We have failures in commodity markets. The whole credit crisis. And so once you mix that into the fold, how can you predict what the aggregate effect of just that piece of tax legislation is? And I would argue we really don’t know.”
Economists Alexander Ljungqvist of New York University’s Stern School of Business and Michael Smolyansky of the Federal Reserve recently tried to answer the question by looking at fluctuations in corporate tax rates at the state level.
Some large metropolitan areas, such as Philadelphia and St. Louis, overlap two or more states. When one of those states changes its corporate tax rate, do growth rates change in one part of the region but not the other?
Their conclusion: Tax increases can hurt a region’s economy, but no evidence exists that tax cuts spur growth.
Ljungqvist and Smolyansky say the one exception to that rule is during recessions. When an economy is contracting, corporate profits fall and loans are harder to get. Businesses have trouble getting money to invest. At times like that, a tax cut can be just what businesses need.
There’s just one problem. The U.S. economy isn’t in a recession right now. It’s in the longest postwar economic expansion on record, with very low interest rates and very high corporate profits.
In fact, most corporations have access to pretty much all the money they need right now, says Josh Bivens, director of research at the liberal-leaning Economic Policy Institute. But they’re not investing all that much or increasing wages.
“So we have exactly what the corporate tax cut is trying to engineer—really high post-tax profit rates. And yet it has not resulted in more investment. So the idea that we just want to do more of the same thing that has not spurred investment strikes me as not correct,” Bivens says.
“We’re … in a time period where we’re really awash in capital,” says Clausing. “World savings are very high. [Former Federal Reserve Chairman] Ben Bernanke has described this as a savings glut problem. There’s just very low interest rates and lots of sources of capital.
“The reason firms aren’t investing is because of a lack of investment opportunities, not because they need more tax incentives to do so,” she adds.
That points to a much larger and more formidable problem for the economy, one that the U.S. and other advanced economies have struggled to explain.
After a record economic expansion, companies still don’t see a lot of reasons to invest out there. Giving them even more money by cutting their taxes, Bivens says, isn’t going to address the real problems the economy faces.