The Tax Cuts and Jobs Act (TCJA) signed into law on December 22, 2017, made significant changes in the personal and business income tax systems.2 A central objective of the law was to lower the tax burden on businesses and encourage them to increase investment. The TCJA permanently cut the statutory corporate income tax rate from 35 to 21 percent and introduced temporary capital expensing, allowing companies to fully deduct certain types of capital spending from their pre-tax earnings.3 It also introduced international tax provisions aimed at encouraging companies to repatriate foreign earnings and invest them in the United States. The cost of the TCJA is estimated at some US$1.9 trillion over 10 years (Congressional Budget Office 2018).4
More than a year after the passage of the TCJA, there is no consensus on how strongly it has stimulated private fixed investment. Some argue that, by lowering the cost of capital, the TCJA’s tax provisions have significantly increased business investment (Council of Economic Advisers 2019). Others argue that businesses have used only a small portion of the cash freed up by the TCJA to increase investment (Krugman 2018, for example). It may be that a full assessment of the effects of the TCJA will need to await availability of more data, including to reflect lags in the issuance of regulations for certain provisions of the law.
This paper presents a preliminary assessment, based on available data, of the performance of U.S. investment since the passage of the TCJA from three different angles. First, we take stock of how private investment has performed since 2017 compared to forecasts made before the TCJA. To put U.S. investment performance into international perspective, we also conduct this comparison for other advanced economies. We additionally examine whether U.S. investment growth has been broad-based or driven by specific investment categories or economic sectors. Second, we investigate how much of the investment growth in 2018 reflects the strength of aggregate demand. In particular, we assess how much of the rise in non-residential (business) investment compared with pre-TCJA forecasts is explained by the theoretical relationship between investment and expectations of future demand. Third, we assess the investment outturn against what could have been expected based on the empirical literature on how economic activity and investment respond to postwar U.S. changes in tax policy.
Our findings indicate that U.S. non-residential (business) investment growth since 2017 has been strong. As we report in Section I, the level of U.S. business investment reached by the end of 2018 was about 4.5 percent higher than forecasters had generally anticipated in the Fall of 2017, before the enactment of the TCJA. On a Q4/Q4 basis, business investment growth in 2018 was greater than had been anticipated by 3.5 percentage points. This overperformance was stronger than that seen in other advanced economies, where investment growth was broadly in line with or below expectations. Components of U.S. business investment that grew especially strongly compared to pre-TCJA forecasts were equipment and software, and intellectual property.
At the same time, the overall strength in aggregate demand appears to have been the primary driver of the rise in business investment since 2017. As Section II reports, the rise in business investment is consistent with a forward-looking accelerator model in which investment responds to expectations of future overall demand, as measured by private-sector forecasts of growth in the non-investment part of output. This suggests that factors that raised aggregate demand—including the rise in disposable income from the TCJA and higher government spending from the 2018 Bipartisan Budget Act (BBA)—encouraged companies to expand capacity to meet the incremental customer demand. There appears to be little unexplained component of business investment beyond the expected demand effect. Other factors, such as reductions in the cost of capital, thus appear to have played a relatively minor role. This result is consistent with surveys of both large and small companies, which show that only 10-25 percent of businesses attributed planned increases in investment to the 2017 changes in the tax code. Moreover, balance sheet data for listed (S&P500) firms suggest that only about 20 percent of the increase in corporate cash balances since the passage of the TCJA has been used for capital and R&D spending. Much of the remainder was used for share buybacks, dividend payouts, and other asset-liability planning and balance sheet adjustments.
In addition, we find that the investment response to the TCJA thus far has been smaller than would have been predicted based on the effects of previous U.S. tax cut episodes. As Section III explains, empirical studies based on postwar U.S. data suggest that the impact of tax cuts on GDP and investment typically peaks within the first year. When the estimates from these studies are calibrated to the scale of the TCJA tax cuts, following Mertens 2018, the predicted impact on GDP in 2018 averages 1.3 percentage points, and the predicted impact on business investment is 5.2 percentage points on a Q4/Q4 basis. The actual increases in GDP and investment growth since the passage of the TCJA compared with pre-TCJA forecasts have been below these predictions, at 0.7 and 3.5 percentage points, respectively.
In Section IV, we investigate two factors that may have dampened the output and investment response to the TCJA compared to previous postwar episodes of tax cuts: increased economic policy uncertainty and greater corporate market power.
A large literature finds a negative relation between policy uncertainty and business investment.5 We draw on this literature to quantify the impact of the rise in policy uncertainty indices since 2017, which has occurred in the context of growing uncertainty regarding trade and other policies in the United States and other countries. We find that policy uncertainty has played a role in subduing investment growth in 2018.
In a novel contribution, we investigate the role of market power in stunting the impact of the TCJA on business investment compared to previous postwar episodes of tax cuts. A growing literature documents a widespread rise in market power in advanced economies over the past several decades.6 To our knowledge, our paper is the first to investigate the link between the rise in market power and the potency of tax policy changes.7 8 We start by presenting simulation results from the IMF’s Global Integrated Monetary and Fiscal (GIMF) general equilibrium model, which show that a cut to the corporate tax rate theoretically produces a considerably smaller response in investment, output, employment, and real wages when corporate markups are high. Next, we investigate if this theoretical result is also borne out empirically using firm-level investment and employment data for 17 advanced economies, a narrative dataset of fiscal shocks (Guajardo, Leigh, and Pescatori 2014), and estimates of markups at the firm level (Díez, Leigh, and Tambunlertchai 2018). We find that the impact of tax changes on investment and employment is significantly smaller in firms with higher markups. Similar results hold when looking only at 2018 data for U.S. publicly listed companies. Firms with higher estimated markups increased investment (and investment growth) by less in 2018 than those firms who were pricing closer to marginal cost. Section V concludes.
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We are grateful to Nigel Chalk, Benjamin Hunt, Benjamin Carton, Carlos Caceres, Karel Mertens, and numerous IMF seminar participants for helpful comments, to Peter Williams and Dan Pan for excellent research assistance, and to Javier Ochoa for superb editorial support.
The law’s formal title is “HR1: An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”
The TCJA allows 100 percent expensing on new investments in assets with less than 20-year depreciable life through 2022, to be reduced by 20 percentage points per year thereafter. For an overview of the TCJA, see Chalk, Keen and Perry (2018).
This estimated cost incorporates macroeconomic feedback effects, as estimated by the CBO. Without these effects, the estimated static cost is about US$2.3 trillion (CBO 2018).
Krugman (2018) suggests that monopoly power is a factor that has diminished the impact of the TCJA on investment.
Higher market power may additionally affect the optimal level of investment even in the absence of tax policy changes (see Díez, Leigh, and Tambunlertchai 2018). However, in this paper, we investigate a separate issue—whether market power affects the effectiveness of tax policy changes in raising investment.
The Fall 2017 WEO explains (p. 13) that the forecasts were based on the assumption of unchanged U.S. fiscal policies. The Fall 2017 WEO was compiled on the basis of information available through September 18, 2017.
CEA (2019) attributes the pickup in investment in 2017Q4 to firms already shifting forward their investment in reaction to news that full expensing for new equipment would be retroactive to September 2017.
We use the National Income and Product Accounts data from the Bureau of Economic Analysis. Business investment (non-residential fixed investment) growth in 2018 was 7.0 percent on a Q4/Q4 basis. Using an alternative measure of business investment—the sum of private nonresidential fixed investment by (a) nonfinancial corporate business; (b) nonfinancial noncorporate business, and (c) financial institutions, based on the Distribution of Gross Domestic Product data from the Federal Reserve’s Financial Accounts of the United States—real business investment growth in 2018 was 7.4 percent (Q4/Q4). For 2017, the rates of business investment growth based on the above two measures are, respectively, 6.3 and 6.4 percent on a Q4/Q4 basis.
This small contribution also reflects the relatively small share of structures investment in total business investment (around 20 percent).
Our analysis is based on the National Income and Product Accounts statistics, which includes mining activity.
The standard accelerator model is derived as in Jorgenson and Siebert (1968). The empirical specification for the model typically follows Oliner, Rudebusch, and Sichel (1995):
Following the passage of the TCJA at end-2017, the Business Conditions Survey conducted quarterly by the National Association of Business Economics began including the following question in 2018: Has your firm changed any hiring or investment decisions as a result of the 2017 Tax Cuts and Jobs Act? a) has your business accelerated investment?; and b) has your business redirected hiring/investment to the U.S.?
In the NFIB survey about the TCJA, 51 percent of small business owners expected to pay less in federal income tax in 2018. Of those, 47 percent reported planning to increase business investment with their tax savings.
The CEA (2019) calculates the actual impact of the TCJA on GDP at 1.4 percentage points. The non-TCJA baseline growth for 2018 consistent with such an impact on GDP would, given the CEA (2019) forecast for 2018 growth of 3.2 percent, be 1.8 percent. With GDP growth forecasts tracking well above 2 percent through much of 2017, such a low baseline for 2018 growth would be significantly below pre-TCJA forecast made in real time and difficult to reconcile with the strong economic conditions already prevailing.
Altig and others (2019) estimate that the negative impact on manufacturing capital investment was greater, at -4.2 percent, reflecting the greater sensitivity of the sector to international trade.
The 10-year horizon illustrated is chosen for illustrative purposes and the relative magnitudes of the responses are similar over shorter horizons.
The capital stock is measured by data for property, plant, and equipment available in Worldscope.
At the same time, the firms in our sample account for a large share of national economic activity and thus cast light on macroeconomically relevant developments. For 2016, the U.S. firms in the sample have sales equivalent to 79 percent of U.S. GDP.
To approximate the postwar U.S. level of market power, we assume that the level of markups in the 1950s through the 1970s is equal to the average level of markups in the 1980s. This assumption is consistent with the estimates of De Loecker and Eeckhout (2017) for the pre-1980 period. Combining this assumption with our estimates of markups for the 1980-2016 period implies a postwar average markup of 1.25 (25 percent). The estimated markup in 2016 is 1.60 (60 percent). Based on these markup levels and the coefficient estimates in Table 2 (column 1) implies that a rise in markups from the postwar average level to the 2016 level reduces the investment rate response to a 1 percent of GDP tax-based fiscal expansion from 0.92 percentage point to 0.58 percentage point, implying a reduction in the response of 37 percent ((0.58/0.92) - 1).