The American Jobs Plan’s tax provisions are valuable but not the limit on possible spending

The spending in the American Jobs Plan (AJP) is well targeted to meet several (but obviously not all) pressing social needs. Because so much of the spending is temporary and provides needed investments, there is no pressing economic need to “pay” for it with tax increases. Yet the tax provisions in the AJP are also smart and valuable. This post discusses some of the economics of the AJP, with a special focus on these tax provisions. Its main findings are: The bulk of these tax provisions undo some of the worst parts of the Tax Cuts and Jobs Act (TCJA) passed in the first year of the Trump administration. Given this, to make the case that rolling back these parts of the TCJA will harm the U.S. economy, one has to believe that the passage of the TCJA benefited the U.S. economy. There is no evidence this is the case. The entire case for corporate tax cuts benefiting the U.S. economy hinges on the effects on business investment. But business investment growth in the two years following the TCJA’s passage (even before the COVID-19 shock) was cratering, not rising. The vast majority of new revenue that will be raised from the AJP tax provisions will come from taxing “excess profits”—profits accrued by virtue of monopoly or other privileged market positions. As such, this extra revenue will have little to no effect on economic decision-making and hence will not reduce business investment or economic growth more generally. Two “model-based” analyses of the AJP find very different things: Moody’s Analytics forecasts strong positive effects on economic growth over the next 10 years, while the Penn Wharton Budget Model forecasts very slight negative growth effects by 2030. The finding that the AJP might reduce economic growth rests on a number of bad assumptions: that the corporate tax changes will significantly affect economic decision-making and reduce investment; that the productivity gains stemming from public investment are small; that budget deficits will crowd out large amounts of private capital formation over the next decade; and that AJP’s care investments will reduce labor supply. None of these assumptions are likely to be correct. Ignoring the sad lessons of the Tax Cuts and Jobs Act The signature economic policy achievement of the Trump administration (at least before the COVID-19 shock) was the TCJA, which was largely a corporate tax cut (among other things, it reduced the corporate income tax rate from 35% to 21%). In the run-up to passage of the TCJA, a long debate about the likely effects of corporate tax cuts was waged. The Trump administration made bold claims that the passage of the TCJA would lead to immediate and large wage increases for U.S. workers. The textbook argument linking corporate tax cuts to wage increases rests on a long series of causal links. First, the lower corporate rate increases the post-tax return to investment and hence makes a larger number of potential investment projects profitable. Second, the higher post-tax return to capital also leads to increased savings (either domestic or foreign) and this increase provides the financing for the increase in desired investment. Third, these two previous influences in turn allow for a greater volume of investments in the capital stock of the business sector—leading to the purchase of more structures, equipment, and research and development services. Fourth, this larger capital stock gives U.S. workers more and better tools with which to do their jobs, increasing their productivity. Fifth, the productivity gains are seamlessly translated into wage gains. As we noted during this previous debate, most of the links of this causal chain are clearly broken. Over the past decade, profit rates and margins in the U.S. corporate sector reached record highs, yet investment was extraordinarily weak. Clearly it was not too-low rates of return muffling investment. This weak investment was almost surely driven overwhelmingly by weak growth of aggregate demand (spending by households, businesses, and governments), and anything that boosted savings would just depress demand even further. Predictably, the passage of the TCJA did not see an investment surge. Instead, business investment in the two years following the TCJA (but before the COVID-19 shock) was notably weak—and getting weaker even before the recession began in March 2020 (see Figure A). Figure A More evidence the Trump tax cuts aren’t working as advertised : Change in real, nonresidential fixed investment shows no investment boom Years Real, nonresidential fixed investment 2003-Q1 -2.3% 2003-Q2 1.6% 2003-Q3 4.0% 2003-Q4 6.8% 2004-Q1 5.2% 2004-Q2 4.9% 2004-Q3 5.7% 2004-Q4 6.5% 2005-Q1 9.2% 2005-Q2 8.2% 2005-Q3 7.4% 2005-Q4 6.1% 2006-Q1 8.0% 2006-Q2 8.2% 2006-Q3 7.8% 2006-Q4 8.1% 2007-Q1 6.5% 2007-Q2 7.0% 2007-Q3 6.8% 2007-Q4 7.3% 2008-Q1 5.8% 2008-Q2 3.8% 2008-Q3 0.2% 2008-Q4 -7.0% 2009-Q1 -14.4% 2009-Q2 -17.1% 2009-Q3 -16.1% 2009-Q4 -10.3% 2010-Q1 -2.3% 2010-Q2 4.1% 2010-Q3 7.5% 2010-Q4 8.9% 2011-Q1 8.0% 2011-Q2 7.3% 2011-Q3 9.3% 2011-Q4 10.0% 2012-Q1 12.9% 2012-Q2 12.6% 2012-Q3 7.2% 2012-Q4 5.6% 2013-Q1 4.3% 2013-Q2 2.3% 2013-Q3 4.4% 2013-Q4 5.4% 2014-Q1 5.5% 2014-Q2 8.1% 2014-Q3 8.4% 2014-Q4 6.9% 2015-Q1 5.3% 2015-Q2 3.0% 2015-Q3 1.3% 2015-Q4 -0.1% 2016-Q1 -0.3% 2016-Q2 -0.1% 2016-Q3 0.7% 2016-Q4 1.8% 2017-Q1 3.6% 2017-Q2 3.6% 2017-Q3 2.9% 2017-Q4 4.8% 2018-Q1 6.4% 2018-Q2 7.4% 2018-Q3 7.5% 2018-Q4 6.5% 2019-Q1 4.5% 2019-Q2 2.9% 2019-Q3 2.7% 2019-Q4 1.4% 2020-Q1 -1.3% 2020-Q2 -8.9%