Corporate Tax Cut to Yield More Investment & Wages, Gradually
posted by Michael Lewis on May 11, 2018 - 9:21pm
How long should it take for stimulus from the tax cut to appear? Although the Tax Cuts and Jobs Act became law only five months ago, liberal pundits are already complaining that “folks on Main Street have yet to receive their invitations to the party.” Even GOP Senator Marco Rubio (R-FL), at one point considered a leader of the party, has fretted that “there’s no evidence whatsoever that the [corporate tax cut] has been massively poured back into the American worker.”
There is some substance to their complaints. Despite the tax cut, real GDP growth decelerated in 18Q1 -- just +2.3%, down from a near +3% average in the prior three quarters. Real equipment spending moderated from a double-digit pace in 2017-H2 to less than +5% in 18Q1. Wage growth has been mired just above +2.5%, clearly lackluster for “full employment.”
How long do we have to wait for this fiscal stimulus? Or should we heed Nancy Pelosi as she channels her inner Gerschwins, and “let’s call the whole thing off?”
The short answer, FMI believes, is that stimulus is already occurring, but it will take a while to garner all the economic benefits. That it would happen instantly is wildly optimistic. Yes, Trump and Co. over-promised -- they are politicians -- but the end results will be significant.
The consumer elements should be mostly in place within the year (with a few benefits coming the year after). The corporate response should ramp up over the next few years, which, in turn, will feed into individuals through higher wages.
The tax cuts are comprised of two parts, corporate and individual. On the individual side, there are a few delays, which are deferring income gains and hence pushing back the corresponding boost in consumption. While the new individual tax rates took effect on January 1, the IRS did not publish the revised withholding tables until a few weeks later and employers were not required to begin using them until February 15. Some firms, particularly those using payroll services, were able to adjust withholding immediately. Others over-withheld for the first six weeks of the year; those taxpayers will end up with a larger refund when they file their 2018 taxes early next year. Starting in March, everyone saw the full benefits of lighter withholding in their paychecks, which means spending should be beginning to pick up now.
These tax cuts were tax reforms, expanding the standard deduction and, importantly, doubling the childcare tax credit and extending it to higher incomes. Consequently, many taxpayers will not realize the full benefit until they file their 2018 taxes next year and see a bigger refund.
Also, the law eliminated the Affordable Care Act penalty for not buying insurance, but not for a while. Some five million taxpayers were still on the hook this year for the 2017 ACA penalty, $695 for individuals and more for families, that cut in to their tax refunds. They will have to pay the penalty again for their 2018 taxes due in early 2019 before the penalty finally dies for good.
The tax simplification will pay dividends for many, again starting next year. The percentage of people who itemize deductions will fall from 30% to 10%. Many of those will then choose to do their taxes themselves, saving hundreds of dollars in preparers’ fees (though the benefit will be partially offset by the losses suffered by the tax preparers).
Overall, the American people do not pay as much attention as they should to government policy. Many, if not most, people do not fully grasp the size of the tax cut, especially since Congressional Democrats and much of the media derided those benefits as “crumbs” last year. The Democratic governors of California, New York and New Jersey still rail that the tax cut is costing their residents money through the cap on the deduction for state & local taxes (though in those high-tax states, winners still outnumber losers by at least 8-1 vs. the 11-1 margin in other states).
It will take at least one full tax-year cycle for people to adjust to the new status quo. Meanwhile, the saving rate will likely trend up as consumers are cautious with newfound income in their paychecks. Ultimately, though, consumers spend what they make, so underlying consumption trends will firm.
CORPORATE INVESTMENT TAKES TIME
All the corporate tax cuts were effective on January 1 (the 100% write-off of investment instead of 5-year depreciation was back-dated to September 30, 2017. However, it will take time for firms to adapt their plans to the new, lower rates. Firms spend years planning new facilities, acquisitions and market expansions. Hiring people to staff those facilities et al also takes years. Marco Rubio notwithstanding, no reasonable person could expect corporations to turn tax savings into new investment overnight or even within a few quarters.
Critics have faulted corporations for using their tax cut “windfall” for higher dividends or stock buybacks. But in the absence of immediate capital investment plans/opportunities, this is a better use than retaining cash. Dividends and buybacks are putting cash into the hands of investors who, presumably, will invest in companies that are ready to expand. In any case, stock buybacks are hardly ever permanent: firms buy their own stock now, then issue new shares later when they have a need for more capital. Or they use the higher-valued shares to expand via mergers and acquisitions.
Eventually, this corporate investment must lead to higher labor income. More employees will be hired; with better equipment, workers will be more productive and will be paid accordingly. In early 2018, hundreds of firms did rush out billions of dollars in bonuses to reward (and help retain) employees. Firms’ overall compensation strategies, renegotiating union and other contracts et al will take some more time.
Still, IRS data does suggest that personal income is picking up noticeably. For FY2018 to date, October through April, individual tax revenue has risen a very impressive +11% vs. the same period a year ago. That reflects withholding plus quarterly or other tax payments. This is in spite of the lower tax rates that began in January. Not surprisingly, corporate tax collections have fallen -24% so far in the current fiscal year.
THE TRUTH MAY NOT BE OUT THERE
Finally, FMI would note that even after the economy feels the full benefits of the tax cuts, it may take time for the data to catch up. For all its presumed precision, GDP is predicated on surveys and trends that extrapolate from limited “hard” data. For example, we get complete income results, only with a two-year lag as the IRS tallies all returns. A major tax reform, especially the far-reaching changes here for corporate and sub-chapter S firms, may have some effects on the underlying patterns of activity. It may take an annual GDP benchmark or two, with progressively more complete data, to get a full picture.
In any case, the tax cut is worth at best a few tenths of a percent of GDP growth. It will be blended with the myriad of other factors influencing the economy. Thus, we will never know the exact “truth” about the macro benefits of the tax cuts. Nonetheless, FMI is confident that it will indeed be a modest positive and that the positive will take place in the next two-three years.