Bonus payments and wage increases that immediately followed the law’s enactment weren’t driven by the friendlier treatment of investment, because not enough time had passed for new investments to be made and worker productivity to increase. And the idea was never that the tax cuts would create a pool of money that could be allocated to workers or shareholders or new investment.
The use of immediate tax savings on past investments is beside the point. Instead, businesses will make additional investments in the future in anticipation of larger tax savings on those investments.
There’s plenty of real-world nuance to this simple story, of course.
How sensitive is investment to capital costs and depreciation rates? Some portion of corporate profits are generated by investment activities, and therefore responsive to changes in their tax treatment. But sometimes businesses make profit because of rents, like the loyalty some customers have to a particular brand name. How important is the latter? How long will it take for investment to pick up, and for that to increase productivity, and then for the productivity gains to increase wages? Perhaps most important, by how much should we expect wages to rise? Economists disagree on these issues.
It’s too early to tell whether the corporate tax cuts are working. As has been widely discussed, wage growth is finally accelerating, with a stronger showing in 2018 than 2017. The tax law may have affected wages, but not through the investment-productivity-wages channel I discussed above. (Again, not enough time has passed.) In addition to their impact on that longer-term process, the tax cuts provided a deficit-induced, temporary stimulus to the economy that further tightened labor markets.
The first clue to the corporate tax cut’s lasting effects will not be GDP growth or productivity or wages. Instead, the first place to look is investment. And it’s hard to disentangle the investment effect of the 2017 tax law from fiscal stimulus, regulatory reform, the president’s misguided trade policy and action by the Federal Reserve.
Business investment grew in the 5 percent range in 2017. In 2018, it grew at nearly 7 percent. This is a noticeable quickening. Yet investment growth has been strengthening in nearly every quarter since the end of 2015, so we should be careful in assigning credit to the tax law too hastily. At the same time, it has probably had some impact.
I believe the tax law will eventually strengthen investment and wages. The basic economic argument — that businesses respond to investment incentives, and that investment will affect productivity and wages — is quite compelling. Economics is sometimes about whether, and sometimes about how much. In this case, keep your eye on the how much. And ignore ideologues on both sides.
This article was provided by Bloomberg News.