In December 2017, Congress cut government revenues by passing a $1.5 trillion tax cut. Congress claimed the corporate tax cuts would benefit everyone because businesses would invest or use the tax cut to raise wages. Donald Trump tweeted “TAX CUTS will increase investment in the American economy and in U.S. workers, leading to higher growth, higher wages, and more JOBS!” (Emphasis in his original tweet.) The promise hasn't materialized. Even Fox News, in an August 2018 poll, found Obamacare to be more popular than the tax cuts.
Here is the Fox News poll.
But so far, the cuts have not been linked to an increase in labor share or more investments. The Federal Reserve Bank of Chicago’s current capital spending index indicates private business investment plans have remained in negative territory since 2015. The most certain effect of the tax cuts has been to help fuel a massive increase in the federal deficit and debt.
So where is all the money saved from corporate tax cuts going? First, to companies’ bottom lines and second to stock buybacks, which were recently at a record high. So far, in 2018, the 500 corporations in the S&P Index have received $30 billion from the corporate rate cut, which in turn accounts for over 40 percent of S&P equity earnings growth. When economies are strong, equity values rise because the issuing corporations are engaged in innovation and other fundamental strategies to raise the real performance of the company. However, innovation and fundamental performance do not seem to be the cause of the rise in equity values. The Shiller PE ratio, which compares share prices to earnings, is now over 30, the highest since the expansion began mid 2009.
Buybacks are attractive because most CEO pay is directly linked to stock values and not to productive capital expansion. Increasing pay for the wealthiest Americans and reducing their taxes will boost equity values, but America’s inequality will get worse. The Economic Policy Institute (EPI) documented that 2017 average compensation for the CEO of large companies increased by 17.6%. And that was before the tax cuts kicked in. (Disclosure: I am on the board of EPI.)
Unfortunately, corporations have not used the money they've saved from the tax cut to raise workers’ pay and any potential increase in compensation could be soaked up by health insurance premiums. And, of course, paying more for health insurance doesn’t help households buy food or shelter. Without substantial income growth for most Americans and without new productive investment by businesses, tax cuts will not boost economic growth. Worse, government spending cuts triggered by cuts in tax revenue could cause a recession.
The bond market bolsters the assertion that the tax cut did not boost economic growth. Long-term interest rates remain low, and observers see a recent small bump as a result of the long-term government deficit and debt forecast, not business investment.
If you hold stocks, you have benefited from the cuts pushing up stock prices, though you should beware of a sharp downturn. These P/E and price levels are probably not sustainable, especially with little overall growth and continuing inequality.
But what of the promise that these cuts would benefit all Americans? Most household incomes haven’t received a meaningful increase in after-tax income from the cuts, and since they are skewed to the rich, it is unlikely they will spur a broad-based economic stimulus. Companies are using the cuts to further push up stock prices, not make productive investments.
Regrettably, the President’s tweet turns out not to be true. Perhaps that’s why voters aren’t enthusiastic about the tax cuts. People just aren’t getting any real economic benefits from the tax cuts and they know it.