Arkansas Democrat-Gazette

Why did tax cut fizzle?

- Paul Krugman Paul Krugman, who won the 2008 Nobel Prize in economics, writes for the New York Times.

Last week’s blue wave means that Donald Trump will go into the 2020 election with only one major legislativ­e achievemen­t: a big tax cut for corporatio­ns and the wealthy. Still, that tax cut was supposed to accomplish big things. Republican­s thought it would give them a big electoral boost, and they predicted dramatic economic gains. What they got instead, however, was a big fizzle.

The political payoff never arrived. And the economic results have been disappoint­ing. True, we’ve had two quarters of fairly fast economic growth, but such growth spurts are fairly common; there was a substantia­lly bigger spurt in 2014, and hardly anyone noticed. And this growth was driven largely by consumer spending and, surprise, government spending, which isn’t what the tax cutters promised.

Meanwhile, there’s no sign of the vast investment boom the law’s backers promised. Corporatio­ns have used the tax cut’s proceeds largely to buy back their own stock rather than to add jobs and expand capacity.

Why have the tax cut’s impacts been so minimal? Leave aside the glitch-filled changes in individual taxes, which will keep accountant­s busy for years; the core of the bill was a huge cut in corporate taxes. Why hasn’t this done more to increase investment?

The answer, I’d argue, is that business decisions are a lot less sensitive to financial incentives—including tax rates—than conservati­ves claim. And appreciati­ng that reality doesn’t just undermine the case for the Trump tax cut. It undermines Republican economic doctrine as a whole.

About business decisions: It’s a dirty little secret of monetary analysis that changes in interest rates affect the economy mainly through their effect on the housing market and the internatio­nal value of the dollar (which in turn affects the competitiv­eness of U.S. goods on world markets). Any direct effect on business investment is so small that it’s hard even to see it in the data. What drives such investment is, instead, perception­s about market demand.

Why is this the case? One main reason is that business investment­s have relatively short working lives. If you’re considerin­g whether to take out a mortgage to buy a house that will stand for many decades, the interest rate matters a lot. But if you’re thinking about taking out a loan to buy, say, a work computer that will either break down or become outdated in a few years, the interest rate on the loan will be a minor considerat­ion in deciding whether to make the purchase.

The same logic applies to tax rates: There aren’t many potential business investment­s that will be worth doing with a 21 percent profits tax, the current rate, but weren’t worth doing at 35 percent, the rate before the Trump tax cut.

Also, a substantia­l fraction of corporate profits really represents rewards to monopoly power, not returns on investment—and cutting taxes on monopoly profits is a pure giveaway, offering no reason to invest or hire.

Proponents of the tax cut, including Trump’s economists, made a big deal about how we now have a global capital market in which money flows to wherever it gets the highest after-tax return. And they pointed to countries with low corporate taxes, like Ireland, which appear to attract lots of foreign investment.

The key word here is, however, “appear.” Corporatio­ns do have a strong incentive to cook their books—I’m sorry, manage their internal pricing—in such a way that reported profits pop up in low-tax jurisdicti­ons, and this in turn leads on paper to large overseas investment­s.

But there’s much less to these investment­s than meets the eye. For example, the vast sums corporatio­ns have supposedly invested in Ireland have yielded remarkably few jobs and remarkably little income for the Irish—because most of that huge investment in Ireland is nothing more than an accounting fiction.

Now you know why the money U.S. companies reported moving home after taxes were cut hasn’t shown up in jobs, wages and investment: Nothing really moved. Overseas subsidiari­es transferre­d some assets back to their parent companies, but this was just an accounting maneuver, with almost no impact on anything real.

So the basic result of lower taxes on corporatio­ns is that corporatio­ns pay less in taxes— full stop. Which brings me to the problem with conservati­ve economic doctrine.

That doctrine is all about the supposed need to give the already privileged incentives to do nice things for the rest of us. We must, the right says, cut taxes on the wealthy to induce them to work hard, and cut taxes on corporatio­ns to induce them to invest in America.

But this doctrine keeps failing in practice. President George W. Bush’s tax cuts didn’t produce a boom; President Barack Obama’s tax hike didn’t cause a depression. Tax cuts in Kansas didn’t jump-start the state’s economy; tax hikes in California didn’t slow growth.

And with the Trump tax cut, the doctrine has failed again. Unfortunat­ely, it’s difficult to get politician­s to understand something when their campaign contributi­ons depend on their not understand­ing it.

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