Research Highlights Podcast
November 20, 2024
Assessing the Effects of the 2017 Tax Cut and Jobs Act
Eric Zwick discusses the impact of the TCJA on the tax code and the economy.
Source: R.Babakin
In 2017, then-President Trump signed into law the Tax Cut and Jobs Act, which was arguably the largest corporate tax cut in US history. The TCJA significantly lowered the statutory rate that corporations pay in taxes and reshaped numerous tax rules. Proponents said it would boost US competitiveness on the international stage and juice business investment. But its overall effects are still being debated among economists.
In a paper in the Journal of Economic Perspectives, authors Gabriel Chodorow-Reich, Owen Zidar, and Eric Zwick explored the current understanding of the TCJA, discussing its costs and benefits, as well as future policy implications. They argue that, contrary to what some proponents said, the tax cuts significantly reduced tax revenues.
Zwick recently spoke with Tyler Smith about the legislation, who benefited the most from the bill, and whether provisions that are set to expire in the coming years should be retained.
The edited highlights of that conversation are below, and the full interview can be heard using the podcast player.
Tyler Smith: You say that the TCJA was the biggest business tax cut in US history. Can you put the size of this cut in context?
Eric Zwick: There are several ways to think about this. The statutory corporate tax rate went from 35 percent for $1 of corporate income to 21 percent. So it's a 14 percentage point change in the rate. That is a very large change. I think there are some changes in history that were of that order of magnitude, but since the 1980s at least, we haven't seen changes in marginal rates anywhere close to that. What makes it the biggest tax cut in US history comes from taking the change in corporate tax collections that was forecast relative to GDP. So that was on the order of half a percent of GDP to 75 basis points of GDP. And then if you just think about the cost of capital, which is the price for a firm to make a dollar of investment, there's a tax component of that. The change in that tax component was also quite large relative to other big tax changes in the past, such as in the 1950s and 1980s.
Smith: Besides cutting the statutory tax rate on businesses, what else did the TCJA do that's important to understand?
Zwick: The rate cut is the most salient and also the easiest to understand. The next easiest to understand is the way we allow firms to take deductions against income when they buy equipment or machines or make certain investments. We basically moved from a system of accelerated depreciation to full expensing. For example, when you buy a laptop and it lasts five years, you get to deduct the full price of the laptop against your income in the year of purchase. That's what we call narrowing the base because it's shrinking the amount of income that a firm then applies to the 21 percent rate. There were a bunch of additional provisions that changed the definition of the base or changed the rate that a few people pay. For example, there was a special carve out for manufacturing firms that reduced their tax rate, and that went away.
Then there's a bunch of foreign income tax rules. We basically used to have a system where firms operating in multiple countries, including the US, would owe tax on the income that they earned abroad, but they wouldn't have to pay tax until they brought that income back or repatriated it. So, we had a bunch of firms that were sort of letting it sit over there, accumulating, hoping that there would be a holiday where they would get to pay a lower rate. We got rid of that system and moved to a system where you only have to pay tax on your US income at the 21% rate.
An additional change for businesses was a reduced tax rate for certain pass-through businesses, to bring that tax rate closer to the rate that traditional companies would face. Pass-through businesses aren't taxed at the entity level, so the 35% to 21% tax rate reduction doesn't apply to them. They're actually taxed at the individual income tax rate. So if you own a pass-through business—which most small, closely held and mid-market businesses are in the US—you pay a lower rate. That was meant to bring the rate closer to the corporate rate.
Smith: Did you find any evidence that the TCJA boosted investments enough to offset the tax cuts?
Zwick: This is an active research literature, and we looked across this literature to see different ways of estimating the effect. It's a very complex reform, so to estimate the effect on investment you have to be creative. And all methods have their criticisms too. But looking across the literature at the different methods, we find evidence that there is an increase in investment that is nontrivial. But if you take into account the additional growth and income, both for firms and also for workers at those firms, from that additional investment, it's far too small to offset the direct mechanical cost of the reform.
Smith: Do you think that these changes made the US tax code more competitive globally?
Zwick: We reduced the effective corporate rate a fair amount, and that definitely to a first order makes it more attractive to do business in the US than it was previously. We have evidence there's investment increases in the US for firms that are operating in both the US and elsewhere, and we find evidence that they also increase investment elsewhere. Also this territorial system is creating a strong incentive to have income elsewhere, too. But we do find over and above the effect of the domestic reform, what's going on on the international side seems to boost foreign investment, which has some spillover effects back to US investment, which is an interesting result that speaks to the way multinational firms operate. It adds some nuance to the debate.
We find evidence that there is an increase in investment that is nontrivial. But if you take into account the additional growth and income, both for firms and also for workers at those firms, from that additional investment, it's far too small to offset the direct mechanical cost of the reform.
Eric Zwick
Smith: How did the TCJA impact jobs and wages?
Zwick: The most direct way that it would affect jobs is through more investment, which means more capital, and capital usually also comes with labor. More workers are needed and that increases productivity, which increases wages for the workers there. It basically generates an increase in labor demand, which should have some employment effect. There is limited evidence of direct employment effects in the short run after the reform. There's a wage response that's on the order of a half a percent to a percent of income that seems to be concentrated at the very top of the worker earnings distribution, such as CEOs. If it takes firms a while to adjust in terms of investing and adding capital and hiring more workers, then we would expect it to take maybe five to ten years to show up in wages elsewhere. But if you take an off-the-shelf model and walk forward the short-run response, you see wage increases again on the order of half a percent to a percent of baseline income per year. That works out to roughly $500 to $1,000 of earnings. The proponents from the Council of Economic Advisers and elsewhere around the time of the reform were suggesting that the number would be more like $4,000 to $9,000 per worker.
Smith: Some of the provisions in the TCJA are set to expire. Do you think that we should let them expire or should they be renewed? Or should we have a bigger overhaul of the business tax regime?
Zwick: We have suggested that, on the margin, if you're trading off between things like the corporate tax rate and things like the depreciation deductions or incentives for research and development, the latter are better for growth in terms of bang for your buck, and they're less of a direct transfer to shareholders. To the extent that we're revisiting these different provisions, the R&D things have basically phased in and become less generous. Accelerated depreciation is phasing out. You’d really like to bring those back to TCJA levels at the beginning of the reform and reinstate the R&D, but maybe at the expense of raising the corporate rate. That would seem like a fruitful trade-off. Another one would be the pass-through tax changes. Those changes seem to have less evidence suggesting they have any effect on growth. They really look like a transfer to the firms’ owners. If we were to let those expire, that would be pretty regressive and probably have little impact on growth. Letting those expire could make sense.
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“Lessons from the Biggest Business Tax Cut in US History” appears in the Summer 2024 issue of the Journal of Economic Perspectives. Music in the audio is by Podington Bear.