Investment and Tax Reform

March 23, 2018 Leave a comment

The tax reform recently enacted should have an impact upon investment spending by firms. In a previous post, I argued that the ability to expense (deduct from revenue in the computation of taxable income) all of the investment done by firms in a year should cause investment to rise in the U.S. This is crucial because our living standards depend in part on the stock of capital goods in our economy which in turn affects labor productivity.  More capital should enhance or increase the productivity of labor and thus real wages.

For future reference, it is a good idea to get a look at some data so that, in a future post when more data is available, we can see if investment has responded to tax reform. For this reason, consider the following table.

GDP NRFI NRFI/GDP
2017:01 19057.705 2383.409 12.51
2017:02 19250.009 2433.551 12.64
2017:03 19500.602 2468.374 12.66
2017:04 19736.491 2511.182 12.72

In the table for the year 2017, quarterly GDP is given (so we have GDP in the range of $19 Trillion), NRFI is Nonresidential Fixed Investment, a sensible measure of investment spending by firms, and the ratio of NFRI to GDP.  So we see that about 12.5 percent of GDP has been devoted to building additional nonresidential plant and equipment.

An increase in this ratio would be a reasonable measure showing that tax reform is actually raising investment in the U.S. We will see if this is the case when new data for 2018 is available.

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Incentives Matter

January 20, 2018 1 comment

I have stated on this blog that if the social science of economics is about anything, it is about the powerful economic effects of incentives. The recent media reports about Apple and other firms building new plants in the U.S., raising money wage rates, and increasing employment, are extraordinary examples of how powerful incentives can be in changing economic behavior. All of these stories stem from the tax reform recently passed.

  1. Real Wages. I stated that reducing the corporate tax rate would increase the demand for labor and cause real wages to rise. We have already had announcements about higher money, and thus real, wages paid by firms.
  2. New Plant and Equipment. Apple announed that it will build new plant in the U.S. as other firms have stated as a result of the tax reform.
  3. Tax Revenue. Much has been written about the fact that firms refused to bring money back to the U.S. to avoid double taxation of their income. Apple will pay $38 Billion in taxes once it returns funds to the U.S. so the federal government gets a one-time windfall of revenue due to the tax reform from Apple.
  4. Employment. Apple and other firms are planning to increase employment, with Apple stating that it will hire 20,000 people.

There are other examples (yes they are anecdotes) that I can give but those above make the point. What is most entertaining is to watch Democratic politicians pretend that these effects are nonexistent when, in fact, they should set off a growth boom of the sort that we have not seen in many years. First quarter GDP numbers should be most interesting when they are released. Stay tuned.

But another lesson from these events is how easy it is for government to reduce economic activity or economic growth when it imposes its policies.

All of this provides a wonderful set of examples of economics in action. This is why I got interested in economics when I was a student because it has so much to offer for understanding the world around us.

The Obama Growth Record

January 4, 2018 Leave a comment

The final aspect of the new tax bill is that it may increase economic growth and so I thought I would post a final bit of data to be used down the road in assessing the impact of the new tax reform. And that data is the growth rate of real output in the economy during the two terms of Barack Obama and the record for President Trump.

The Obama Record

After the eight years that President Obama was in office, we can provide the annualized quarterly growth rates that occurred during those two terms. Using data from the Bureau of Economic Analysis (www.bea.gov), the average over 2009-2016 is 1.8 percent (some quarterly data was provided in this post). As I pointed out previously, this is below the long-run growth rate of three percent that the U.S. generated over the century ending at the onset of the last recession. It is a bit unfair to use the first quarter or two of a presidency since the new president can hardly be blamed for what he/she inherited but we need a consistent measure so this seems as good as any.

The Trump Record

We have only a few data points regarding the President Trump growth record but here is what is available: 2017Q1 1.2 percent, 2017Q2 3.1 percent, 2017Q3 3.2 percent. This is an average of 2.5 percent which is a substantial improvement over the Obama record. The existing numbers don’t mean all that much since there are so few of them but we will see if this persists. If it does, this will provide some evidence that the tax reform has had the impact anticipated by its designers.

Real Wages

January 2, 2018 Leave a comment

In two recent posts, I pointed out that the new tax bill should cause real wages to rise for two reasons. One is that the reduced corporate tax rate increases the after-tax profitability of labor which will increase the demand for labor. Second, the expensing of new capital goods reduces the cost of capital goods which should cause firms to add to their capital stocks and thus increase the productivity of workers. This also should increase the demand for labor. As a result, we would predict that real wages for workers should rise. Here I thought I would provide some data on real wages to be used for assessing our predictions about the effects of the recent tax reform. Read more…

Anecdotes

December 28, 2017 Leave a comment

I have been a professional economist for many years and one of the things I noticed early on in my career was how little impact economists have upon public discussion of economic issues. While there are undoubtedly many reasons for this, one obvious reason is the inability of professional economists, particularly academic ones, to communicate with the public in a way which the public understands. Let me illustrate this with two possible ways that we might describe the problems with guaranteed issue, a feature of Obamacare that I have written about in earlier posts which is an important reason for the collapse of the insurance exchanges. Read more…

Expensing New Capital Goods

December 28, 2017 Leave a comment

My last post described a simple story about the new tax reform passed by the federal government regarding the effect of the corporate tax rate and labor demand. There is another aspect of that story which involved the capital stock and the tax rate on corporations and I pointed out that the reduced corporate tax rate would stimulate capital investment which would also increase real wages. But another provision of the new tax bill also affects real wages and the capital stock. That aspect of the bill is the expensing of new capital goods. This feature of the tax bill has the effect of reducing the cost of new capital goods. Read more…

Tax Rates and the Firm

December 27, 2017 Leave a comment

Congress just passed a tax code reform reducing tax rates for firms. Firms announce they will increase the minimum wage rate that they pay workers. What’s the connection between these two events?

Tax Rates and Factor Productivity

Econ 101 students are told a very simple story about the behavior of firms, namely they are told that firms want to maximize profits when they choose their inputs in production. This isn’t literally true but it is a simple story designed to illustrate insights about labor and capital demand and how they generate the demand for inputs in factor (labor and capital) markets. That story leads to the condition

Marginal Revenue = Marginal Costs

for inputs like labor and capital used to produce output. Marginal revenue in this simple story is not taxed but suppose that it is. Then we would amend the story to state that

After-Tax Marginal Revenue = Marginal Costs

which is similar but now the condition recognizes that the government taxes away part of the marginal revenue earned by the firm when using labor and capital. Both of these conditions can be used to generate the demand for inputs in production. Read more…

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