by David R. Henderson
When Congress passed the 2017 tax cut legislation and former President Trump signed it, I predicted that it would work. Cutting the corporate income tax rate from 35 percent to 21 percent would increase firms’ incentive to invest because they would keep more of their profits. The tax cut brought the U.S. corporate tax rate much closer to that of other developed countries. So, I thought, the United States would be more competitive in attracting investment. Because capital markets are global, capital can move quickly from one country to another, and the high U.S. tax rate was discouraging that movement to the United States.
Interestingly, many people who doubted there would be a strong effect on incentives also thought that corporations were full of greedy people. They never explained why corporations’ greed would suddenly evaporate when they contemplated newly lucrative investment opportunities.
My prediction was based not only on my own economic understanding but also on the reasoning given by Kevin Hassett, who was chairman of the Council of Economic Advisers (CEA) under President Trump. In the February 2018 Economic Report of the President, Hassett and his CEA colleagues predicted an increase in corporate investment that would make workers more productive, leading to higher wages and higher incomes for average families.
That’s exactly what happened. By 2019, write Hassett and co-author Tyler Goodspeed in the May 9 Wall Street Journal, business investment was 9.4 percent above its pre-2017 trend. In 2018, they had predicted that the tax cut would cause average household income to increase by $4,000 over three to five years. In fact, note Goodspeed and Hassett, the economy did better than that: “In 2018 and 2019 real median household income in the U.S. rose by $5,000.” Median and average are not the same, but they’re close.
I did not predict that the tax cut would overperform in another way with its effect on corporate tax revenues. Normally, when a government cuts a tax rate, the amount of revenue it collects declines. That’s because the percentage increase in output due to the tax cut is less than the percentage reduction in the tax rate. In this case, though, the effect was an increase in federal tax revenues on corporate income.
In 2017 the Congressional Budget Office estimated that the tax cut would cause corporate income tax revenues in Fiscal Year 2022 to be $353 billion—lower than the $389 billion that they predicted without a tax cut. The actual result? In 2022, according to the Tax Foundation, corporate income tax revenues will hit a whopping $454 billion, even higher than without a tax cut.
The 2017 tax cut overperformed. Although it highlights how bad CBO estimates can be, it’s very good news for the economy.
Originally published by the Institute for Policy Innovation. Republished with permission. For more great content from Budget & Tax News.
