BY R. GLENN HUBBARD
To frame any discussion of the effects of the Tax Cuts and Jobs Act of 2017 (TCJA) and next steps for tax reform, it is important to remember the evolution in economic thinking and economic policymaking that led to the TCJA.
For decades, economists and policy analysts had drawn on the work of Arnold Harberger, whose two-sector general equilibrium model (of a closed economy with fixed factor supplies) concluded that the burden of the corporate tax fell on owners of all capital. Two shifts led to a change in view of the corporate tax. Within the economics profession, researchers studying tax policy’s effect on investment cast doubt on models that assumed away effects on capital accumulation (more below). And increases in international corporate capital mobility led to shifts in thought as to how much of the burden of the corporate tax is borne by domestic capital; more recent studies find that labor bears much of the burden of the corporate tax.
These strands of thought influenced tax emphasis toward reform of the corporate tax, as opposed to concentrating on reforms of individual capital income taxation stressed by the 2003 tax reduction in dividend and capital gains taxes to reduce the double taxation of corporate equity-financed investments. Accordingly, an assessment of the shift embodied in TCJA should consider its effects on investment and pathways for future tax reforms.
Economists have observed for some time that measuring effects of business tax changes on investment in aggregate data is challenging because of policy endogeneity — that is, Congress tends to reduce taxes in downturns and raise them in upturns. That realization led to research exploiting cross-sectional differences in response to major tax reforms in a series of papers for US and non-US country tax reforms by Jason Cummins, Kevin Hassett, and me. Those studies estimated significant response of business investment to changes in the user cost of capital or q-type measure in response to tax reform.
Using such estimates, then–Council of Economic Advisers Chairman Kevin Hassett presented to the January 2019 meeting of the American Economic Association results indicating that TJCA had raised business investment one year in, and that the greater investment has played a significant role in explaining the higher real GDP growth from the 2009 Q3–2016 Q4 average to the 2018 Q1–2018 Q3 average. In that presentation, Hassett also suggested using data from 2018 that the cross-sectional pattern in the reform holds — that is, sectors with greater reductions in the user cost of capital experienced higher investment. In ongoing work, Jon Hartley, Kyle Kost, and I are estimating similarly strong effects of the tax change on investment using disaggregated data.
After the pickup in investment after the passage of TCJA (documented by the Council of Economic Advisers), why are we not seeing a smooth path to future gains? A key stumbling block, of course, is the increase in policy uncertainty, which raises the hurdle rate for new investment. Seen this way, the present policy uncertainty — principally stemming from erratic trade policy — has reversed part of the TCJA’s pro-investment contributions.
Going forward, two paths are likely. The first is incremental change in domestic or multinational corporate taxation or in noncorporate business taxation. Changes could address the tax code’s permanence on the individual side (for a Republican initiative) or an increase in the corporate tax rate (for a Democratic initiative).
More interesting would be a second path toward more fundamental tax reform. Promising in this regard would be a reexamination of a destination-based cash flow tax. Such a reform offers gains in efficiency and incremental revenue in the near term from border adjustments in the tax’s implementation. The burden of a business cash flow tax falls on existing assets — wealth — a feature of potential interest in the debate over wealth taxation. Combined with a wage tax at the same rate, the cash flow tax produces a consumption tax as a stable, broad-based source of revenue. Graduated wage tax rates for top wage earners and an expanded earned income tax credit for low-wage earners would add progressivity to the reformed tax system.
R. Glenn Hubbard is the John H. Makin Visiting Scholar for 2019–20 at the AEI and a dean emeritus/Russell L. Carson Professor of Economics and Finance at Columbia.
This article is part of a series dedicated to analyzing the impact of the Tax Cuts and Jobs Act. Click here to return to the series.