David R. Henderson  

Cutting Corporate Tax Rates in 2018 or 2019: It Matters

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What's my core message?... My Excerpt in The Atlantic<...

The important effect of incentives on allocation over time.

One of the differences between the House and Senate versions of the tax cut is whether the corporate tax rate falls in 2018 (House) or 2019 (Senate.) It might look as though it's no big deal. It might well be a big deal, partly economically and, deriving from the economics, partly politically.

You're someone deciding whether to start a new business that you think will make money the first year. Under the House version, the corporate tax rate falls to 20 percent in 2018. So if that provision is kept, you know you'll pay the corporate tax rate of 20 percent on your profits. But if the Senate version is kept, you'll pay, the first year, at 35 percent.

Hmmm. What to do if the Senate version is kept? Wait to invest until 2019. So, to whatever extent the tax cut does increase economic growth, some of that growth will wait until 2019. Why does that matter politically? The midterm elections.


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COMMENTS (8 to date)
Salim writes:

David -

I don't think you have a rich enough model of corporate activity in your head. The bill includes (temporary) expensing for equipment investment. That means that investments can be written off against the tax base in the year they are made.

So if you have an equipment investment that will produce a 10-year stream of profits before it depreciates, most of that stream (in PDV) comes in years that will be taxed at 20%. But the investment can be written off against a 35% rate. The 2019-intro is intended to induce an investment boom in 2018 and to lower the 10-year-budget-window overall cost of the bill.

From the point of view of optimal tax literature, delayed implementation has a bit of the flavor of taxing old capital at a higher rate than new capital, so it is probably an improvement over immediate implementation.

Of course, for rapid enough economic depreciation and/or high enough discount rates on future profits and/or sufficient political uncertainty, delayed implementation becomes worse. There's a good case to be made for phasing the cuts in over 3 or 4 years.

Vivian Darkbloom writes:

"You're someone deciding whether to start a new business that you think will make money the first year."

"Hmmm. What to do if the Senate version is kept? Wait to invest until 2019"

1) Very, very few new businesses make profits the first year. Profits follow investment.

2) And Salim is correct. From an *investment* point of view, there would likely be the opposite effect. Businesses would tend to accelerate investment to 2018 (to offset tax at the 35 percent rate) and defer income to 2019 to enjoy the lower rate on income. The former is particularly true given that the bill calls for immediate expensing of many types of investment.

There may have a mixed effect on reported *accounting* income which may not be equivalent to "economic growth" in the real sense.

Thomas Hutcheson writes:

Does that mean that if you expect your business to lose money the first year, you should prefer to invest sooner while the write off is larger?

I'm not an expert on the subject, but I have heard that the effective corp tax rate is already below 25%. So if they get rid of the deductions businesses have been used to the effective rate could still be about 25%.

Sai writes:

There's a pretty glaring problem that I see with your analysis. Say the House plan passes, and the corporate tax rate falls from 35 percent to 20 percent. The only entities that this tax reduction would benefit are corporations, not proprietorships, partnerships, or LLC's, which most small businesses comprise of. Due to this, the typical small business doesn't pay taxes itself, but the owner(s) do as individuals.
On the topic of investment, I concur with Salim and Vivian. Businesses would accelerate investment while the tax rate is still high so that the investment could be written off at a 35 percent tax rate. A problem I see with this is that it could inflate the owner equities of large corporations during the accounting cycle, making the capital account seem very large in comparison to previous trends. Obviously, this would bounce back down the following year, but all this means is that no real economics growth is being experienced.

Jake writes:

I know we operate on the margin but I don't understand why someone would give up $1 in profit just to avoid 35 cents in tax.

It's the same reason it makes no sense when liberals accuse wealthy people of making charitable donations just to get tax breaks.

robc writes:

Jake,

Simple Hypothetical: At your current job you make .7 net units. Why would you give that up to make .65 when you could wait a year and make .8?

Steven writes:

If the Senate's version of the corporate tax rate plan is kept, business growth in the U.S. will take a major, detrimental hit. Although, business investment will accelerate to compensate for the corporate tax hike, this corporate tax plan will last longer than that year and the acceleration of investments in businesses will not overturn the limited growth that this tax plan will cause. Throughout history, lower tax rates have shown more growth while also lowering the national debt. Although it might seem counterintuitive, you can see this affect by looking at a graph of our national debt and see that any spikes that lower it were caused solely from a president lowering the tax rate. Just like we have seen throughout history, if the Senate's bill is kept, we will see limited growth when compared to the House's version of the corporate tax plan.

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