Will sweeping corporate-tax cuts succeed in juicing the US economy and buoying middle-class wage growth? Most assuredly, says the Trump administration, with Congress poised to pass the Republican tax bill.
The Trump team’s argument goes something like this: Cutting taxes on businesses will free up profits they will invest in new factories, research and development, and new equipment. The resulting investment boom will spur growth, as firms hire and as workers harness new ideas and equipment to produce more than they used to.
Let’s look at what happened the last time the US tested this logic. In 1986, Ronald Reagan signed cuts that brought corporate taxes to 35%, down from 48%.
“That’s as large a cut as we’re talking about today, and investment fell-that was the weakest period of investment in the postwar period”, Dean Baker, economist and co-director of the Center for Economic and Policy Research (CEPR), an independent, nonpartisan think tank, tells Quartz. “I’m not going to say that was because we cut the taxes, but it’s a little hard to believe that it will boost investment this time.”
As a share of GDP, gross business investment peaked in 1982, at more than 15%. That share dropped sharply starting in 1987.
In the five years after the tax cut, investment growth averaged 1.6%, compared with more than 8% between 1977 and 1981.
What this colossal fiscal experiment suggests is that tax rates and after-tax share of profits weren’t driving business-investment decisions.
“Firms weren’t cash-constrained-they weren’t saying, ‘If only we could have more money, we’d do more investment,’” says Baker. “That’s even more true today. They really don’t know what to do with their money. It’s not as though Apple is sitting there going, ‘We have all these great plans-if only we had the money.’”
One big difference, though, is that current business-investment levels aren’t nearly as high as they were before Reagan’s tax cut.
So what will companies do with a windfall of after-tax profits? The odds that it will flow back into the real economy aren’t looking good. Many major companies are planning to hand that money to their investors through dividends and share buybacks. In fact, when Gary Cohn, Trump’s economic guru, asked a gathering of corporate leaders who was planning to reinvest their tax cuts, few raised their hands, Bloomberg recently reported. “Why aren’t the other hands up?” Cohn asked.
