By Robert Duquette, CPA
Note about updates (Dec. 15, 2019): Since this tax reform review was published in August 2019, there have been a few meaningful economic updates to the original analysis, which have been incorporated below. My own reaction to this updated data is that although we continue to have a strong economy in terms of being at full employment, consistently low inflation, and a stock market at record highs, our national real GDP growth rate is only about 2% this year. This is below the 2.5% rate in 2018 (the first year after tax reform), the 2.8% rate in the year before tax reform, and well below the 5% to 6% that was promised by advocates of the Tax Cuts and Jobs Act.
The importance of GDP growth is that it is a reflection of how large the economic base is. The larger the economic base, the greater the tax receipts and the lower our annual federal deficit would be. The fact is that our current GDP growth is anemic, despite all the other indicators holding up well. The federal debt is now over $23 trillion (over 100% of annual GPD) and it is growing with increases of over a trillion dollars a year (just as the CBO has been predicting for years). If we are running at this level of new debt in our currently lauded good economy, then what will the deficits be when the next recession hits? I had personally hoped that the Tax Cuts and Jobs Act would have been more successful at producing the kind of growth promised. By doing so, it would have perhaps served as a prescription for the far greater growth numbers we need in order to begin taming trillion dollar deficits before an inevitable financial day of reckoning is upon us.
Updates will appear below in italics.
Prior to the passage of the Tax Cuts and Jobs Act (TCJA) in December 2017, the U.S. Congress and the Trump administration both promised numerous favorable outcomes for the economy, fairness in taxation, and tax relief for businesses and all individuals. Specifically, the administration originally proposed
the following tax reform principles and goals (as described in the “Joint Statement of Tax Reform” issued on July 27, 2017, from Congress and the administration), later summarized in the Economic Report of the President and Annual Report of the Council of Economic Advisers
issued February 2018, and further explained by the U.S. Treasury
This article is an ongoing analysis of what was promised when the TCJA was enacted compared with what has actually happened to date1 using nonpartisan, objective, and authoritative sources. Addressing all the key promises and goals of tax reform is complex; here, I analyze the 13 topics above and their intended goals then offer my own personal verdict and opinion (not that of the PICPA) as to whether each goal was achieved and if the TCJA has been successful so far.
1 This analysis originally ran as a five-part blog on PICPA’s CPA Now, and used the most recently available information as of July 2019. This webpage is being periodically updated by the author.
Protect American Jobs
This is a big claim, and there are several ways to measure this, including unemployment rate, labor participation rate, and job growth rate.
Unemployment rate: According to the U.S. Bureau of Labor Statistics (BLS), when the TCJA was enacted, the unemployment rate stood at 4.1% in January 2018; at the time this article was originally written, it was 3.7%. (Update: As of Dec. 15, 2019, the rate was at 3.5%.) It should be noted, however, that unemployment was already declining about a half point each year since 2009, when unemployment was at 10% near the end of the Great Recession.
Based on just this metric, it is not clear if the TCJA was the sole reason for the half point decline in the rate over the past two years. It probably was a relevant factor. Again, the rate was already declining about a half point a year for the past 10 years. And based on my understanding of the definition of full employment, I would think it is difficult to squeeze much more out of the unemployment rate. Regarding whether or not the rate can go much lower, most economists believe that the United States has reached a floor to its unemployment rate, also known as the “structural” or “natural” unemployment rate. Thus, the rate will struggle to keep dropping, regardless of TCJA’s incentives.
Labor participation rate: According to the BLS, this rate (the number of people who are working or looking for work as a percentage of the total population not in the military or institutionalized) averaged about 65% in 2009, the last year of the Great Recession. Shockingly, this rate has generally continued to decline, despite the recession ending. When the TCJA was enacted in early 2018, the labor participation rate was 62.7%; it improved slightly to 62.9% in the first full year after tax reform; and was still at that level at the time this article was originally written. As of Dec. 15, 2019, the rate had improved a bit to 63.2% in November 2019. However, according to the Congressional Budget Office (CBO), this rate is projected to continue downward to about 60% over the next 10 years, further challenging how to grow tax receipts and increasing pressure on curbing entitlement spending. Two of the most significant factors influencing this rate are baby boomer retirees outnumbering new workers and the increasing gap of the types of new jobs created relative to existing workforce skills. The tax cuts and U.S. capital investment incentives of the TCJA did not, and probably could not by themselves, address this disturbing trend.
In the most recent available data (this past April) from the Labor Department, there was a record gap of 1.63 million between the number of job openings and the number of people looking for work.
Job growth: The BLS reports that the average net new monthly jobs created in 2018 (the first full year after the TCJA) was about 225,000, compared with the 2017 monthly average of about 180,000 (which was similar to the monthly average of 185,000 net new jobs under the Obama administration since 2010.) So, for the first year after tax reform, the TCJA appears to have been effective at increasing the net new monthly jobs above the 185,000 average we were averaging since 2010, and well above the approximate 100,000 to 150,000 new jobs per month needed to keep up with population growth.
For most of 2019, the rate had dropped back to the levels before tax reform. Though, as of Dec. 15, 2019, the November net new jobs addition of 260,000 brought up the monthly average for 2019 to 180,000. This is still roughly the same as the seven year average prior to the TCJA. Several theories could explain the inability to maintain the 2018 job growth rates:
- Companies have hit a saturation point or ceiling on how much expansion they can absorb given practical business constraints.
- Companies cannot find adequate numbers of skilled labor to operationalize additional investments due to the country being at the natural lowest unemployment rate and facing a declining labor participation rate.
- Increased use of automation in manufacturing and service jobs is reducing lower-skilled job demand while simultaneously creating difficult-to-fill, higher-skilled jobs.
- Other uncertainties facing businesses, including the current and pending tariff wars. and
- Other goals of tax reform not being realized (discussed subsequently).
The types of jobs created also must be considered, such as ownerships in newly created small businesses vs. higher-paying engineering, construction, or manufacturing jobs vs. lower-paying retail and distribution jobs. (Reliable data is not yet available, but there is preliminary evidence that manufacturing and service sector job growth has improved under TCJA.)
Protecting Jobs Goal Achieved?
Not yet. The growth spike in 2018 may have been short-lived due to labor force constraints, such as a decrease in the number of people available to work or looking for work, and a lack of higher skills among those looking for work compared with the types of jobs available.
(Update: As of Dec. 15, 2019, given everything we now know, it is fair to say that the TCJA protected the jobs we had since enough net new jobs had been created to accommodate population growth. However, the economy’s ability to add substantially more net new jobs is constrained by the above factors, and, without a significant increase, GDP growth will be relatively meager.)
Make Taxes Fairer
The promise behind this pledge was that the TCJA would broaden the taxable income base by removing many special tax breaks and loopholes. I will look at both business and individual taxes in this regard.
Business taxes: The TCJA provided all C corporations with a 40% cut in their rate, from 35% to 21%, to allow them to be more competitive with foreign companies; encouraged the continuation of offshore investments by eliminating most U.S. taxation of normal manufacturing or service profits earned overseas so that those U.S. owned foreign businesses could be more competitive; created immediate expensing provisions to encourage job creation and investments in the United States; and provided a 20% exemption for most small-business ordinary income earned as a pass-through entity to be more competitive with larger businesses. However, it also retained many of the loopholes that allowed multinational corporations to enjoy extremely low effective tax rates.
Individual taxes: The TCJA broadened the tax base for many Americans. It eliminated personal exemptions, several deductions for adjusted gross income (AGI), and many itemized deductions. Most Americans, however, regarded these items as “deserving” rather than “special” tax breaks. In return, the TCJA doubled both the standard deduction and child tax credit.
The TCJA, on average, cut individual tax rates by two to three points for most income brackets, with a greater reduction in the lower brackets. For example, a married couple filing joint (MFJ) with earnings of $50,000 would have paid $6,568 in federal income taxes for 2017, but only $5,619 for 2018. This is a 14.5% reduction (assuming the other TCJA changes were neutral to their situation.) On the other hand, an MFJ couple earning $500,000 would have paid $141,883 in federal income taxes for 2017, but 11% less (only $126,379) for 2018 – again, assuming other TCJA changes were neutral to their situation. From that perspective, the TCJA provided a greater benefit for lower and middle income taxpayers by appearing to give them a larger percentage reduction in tax burden versus the higher income groups.
However, as discussed below, the higher income groups will almost certainly benefit the most from tax reform as a result of several other factors in the TCJA beyond just an individual rate cut:
- Since (according to one study) over 90% of equity investments are owned by the top 20% of earners, they benefit much more from the 40% corporate rate cut from 35% to 21% due to greater corporate dividends and valuations.
- This group can share more in the new multinational permanent exemption of U.S. tax on most foreign earnings.
- They can convert their pass-through entity investments into a C corporation, resulting in a 21% federal tax rate on investment and business income instead of effective federal rates as high as 37%.
- Alternatively, if they keep their businesses as pass-throughs, they may benefit from the 20% pass-through deduction that effectively lowers the top marginal rate on pass-through income from 37% to 29.6%.
- The top portion of this group will benefit from the estate tax exemption doubling from $11 million per couple to $22 million.
Upper income groups argue that they pay a disproportionate amount of the total income tax burden, and therefore should benefit more from tax reform. The Tax Foundation recently published its analysis of IRS data for 2016 and found that the top 5% of income taxpayers (those making above $200,000) pay almost 60% of all individual income taxes, even though they only have 35% of the total reported taxable income, paying an average effective rate of 23%; and the top 1% (those making about $500,000 or more) pay about 37% of the total individual tax, paying an average effective rate of 27%.
Therefore, when the TCJA was passed, the Tax Policy Center (TPC) projected the following:
- For 2018, 65% of the total benefit of tax reform would go to the top 20%; 43% would go to the top 5%; 20% would go to the top 1%; and 8% would go to the top 0.1% of taxpayers. (Actual results are not yet available as of the date of this article.)
- For 2025 (the last year taxpayers will enjoy the individual tax cuts), 66% of the total benefit of tax reform would go to the top 20%; 47% would go to the top 5%; 25% would go to the top 1%; and 11% would go to the top 0.1% of taxpayers.
- In 2027 (after the individual provisions have all expired at the end of 2025), almost all income groups will lose all tax reform benefits, and they will be worse off than before the TCJA due to new inflation index increases in the tax tables. The only exception will be for the top 20%, who will still enjoy the benefits of C corporation tax reform provisions that will not have expired, with 99% of those going to the top 5% and 83% going to just the top 1%.
Data for 2018 tax returns filed regarding the percentage share of total taxes paid by the top 1% or 20% is not yet available due to the fact that most of the tax returns under extension through October 2019 are from these top income groups.
Tax Fairness Goal Achieved?
Yes, for small businesses and multinational corporations since their stated and effective rates came down substantially in the hope that this would fuel expansion in the United States and more competitiveness internationally; and for higher-income taxpayers because, that group would argue, they were paying a disproportionate share of income taxes to begin with.
But probably not as fair for lower and middle income taxpayers when you look beyond the rate cut and account for the relative greater benefits that will accrue to higher-income taxpayers from all the other provisions of tax reform.
Additionally, one could argue that lower rates overall are not necessarily the “fairest” policy for the country over the longer term since tax cuts to stimulate job growth is apparently limited for the reasons stated above, and the cash benefits that are accruing to multinationals and higher-income taxpayers (both with and without small businesses) are projected to raise the federal debt another $2 trillion over 10 years. The growing deficits and related interest costs exacerbated by tax reform may eventually lead to higher income taxes on everyone and/or a reduction in services and safety nets that primarily benefit, and are needed by, the poor and lower middle income taxpayers.
Make Taxes Simpler
Some proponents of the TCJA claimed that filing taxes would be so much easier that it would be akin to filling out a postcard. Let’s review how “simple” filing taxes has become.
Individual taxes: In short, tax filings are simpler for millions more Americans if they do not own a pass-through business. The filing simplicity was achieved by the doubling of the standard deduction, the elimination or capping of numerous deductions, and higher alternative minimum tax (AMT) thresholds. The Joint Committee on Taxation (JCT) last year estimated that the number of filers who would itemize for 2018 “will fall from 46.5 million in 2017 to just over 18 million in 2018, meaning that about 88% of the 150 million households that file taxes will take the increased standard deduction.”
The IRS’s preliminary data for the 2018 tax returns filed through May (after about 90% of returns have been filed, representing about 80% of taxable income) shows that 90% of filers (close to the JCT estimate) used the standard deduction, while 70% did last year in the same period (121 million returns used the standard deduction for 2018 out of 135 million returns filed vs. 94 million out of 134 million returns filed for 2017.) As of Dec. 15, 2019, we are still awaiting the final 2018 tax return data from the IRS, which will include the returns filed under extension.
Note that it was recently reported that due to the doubling of the standard deduction, Americans contributed $54 billion less to charitable causes in 2018 than the prior year based on IRS preliminary data. This conclusion appears to presume that taxpayers contributed less because they no longer received a tax benefit from itemizing their deductions as they did prior to tax reform. There is more here than meets the eye, and the first impression is misleading for two reasons. First, the media’s conclusion is based only on tax returns filed through May 2019 vs May 2018, and (per the IRS) excludes the results of 10% of all tax returns to be filed that are under extension. These are primarily upper income taxpayers (i.e., those most likely to have contributed the most). Second, the conclusion ignores the amount of contributions that were still made by the additional 27 million taxpayers to date who now take the standard deduction: just because the IRS does not know that amount – they can only tabulate what is reported as a charitable contribution on the itemized deduction form – it does not necessarily mean there were fewer contribution. Here is an analogy that would suggest a grossly misleading conclusion: mortgage interest and state and local taxes paid. A comparison of the raw data of itemized deductions for 2018 and 2017 (May to May), shows a drop in the total amount of mortgage interest deduction taken of about $130 billion, and a drop in state and local taxes paid of about $350 billion. This does not mean there was a drastic drop in those amounts paid by taxpayers; these obligations are usually fixed. It simply means they are now taking the standard deduction. Thus, the charitable contribution “drop” resulted from not knowing what those amounts actually are because more taxpayers took the standard deduction and because limitations were placed on the amounts allowable as a deduction. In fact, The Hill reported earlier this year that the Fundraising Effectiveness Project had tabulated that charitable giving was actually up about 1.6% for 2018, although the number of donors was down about 4.5%.
As a result of the lower rates and additional credits, the TPC estimated that many Americans would find that they did not have to file at all, or they would file just to get all their withheld federal income taxes back or possible refundable credits. Specifically, it estimated that the percentage of taxpayers projected to have zero tax or a negative tax liability would increase from 42.7% in 2017 to 44.4% in 2018 as result of tax reform. (Actual results for 2018 returns are not yet available at the date of this article.)
Regarding the “postcard size tax return” promise, the IRS did arguably achieve this although most tax preparers saw this as a gimmick since many taxpayers were required to also prepare up to six new schedules of details, most of which had previously been part of the long form version in 2017.
Business taxes: The filing of these taxes was made substantially more complex, especially for small businesses because of the 20% possible exemption on their qualifying business income (QBI) and for multinational businesses.
On one hand, the TCJA did simplify business taxation by allowing qualifying small businesses to use simpler accounting methods for up to $25 million in receipts versus $5 million to $10 million in receipts before TCJA; allowing 100% immediate expensing on all new or used machinery and equipment; repealing the AMT for C corporations; repealing like-kind exchange treatment for non real estate; and repealing the Section 199 domestic production activities deduction.
For pass-through businesses, however, the new 20% deduction for qualifying business income is extremely complex. The Tax Foundation reports that about 95% of business returns are pass-through entities, including sole proprietorships. Therefore, the QBI deduction was, and continues to be, a challenge through individual extension filing season ending this October.
Furthermore, all C corporations and multinational businesses (in exchange for substantial relief from U.S. taxes on foreign earnings), must wrestle with myriad anti-base erosion provisions, such as “Global Intangible Low Tax Income,” “Foreign-Derived Intangible Income,” “Base Erosion and Anti-Abuse Tax,” and various other provisions attacking their foreign special purpose entities. Multinationals must also deal with the complexity of calculating how much tax they owe on their pre-2018 unrepatriated profits. And, all businesses, including pass-throughs, must deal with the possible application of new interest expense limitations.
One could argue that the above business tax complexity is, for the most part, a small price to pay for lowering the C corporation rate from 35% to 21% and lowering the highest marginal personal tax rate on pass-through business income from 39.6% to effectively 29.6%, assuming they can take advantage of the full 20% QBI deduction.
Make Taxes Simpler Goal Achieved?
Overall, no. The exception would be individual taxpayers without a small business who, for the first time for 2018 returns, did not have to itemize or have no tax liability due to new TCJA provisions.
Make Individual Tax Rates Lower (Especially for middle class taxpayers)
As discussed above, the TCJA did cut the average individual tax rate two to three points for most income brackets, doubled everyone’s standard deduction, doubled the child tax credit, raised the threshold before alternative minimum tax (AMT) is triggered, and provided a 20% exemption on most pass-through income. But it also eliminated personal exemptions, many adjusted gross income (AGI) factors, and several itemized deductions, and capped state and local deductions. As a result, most Americans’ tax bills were scheduled to decrease, but it was not planned to be as dramatic as the rate cuts suggested. Many taxpayers, in fact, found themselves with higher tax liabilities due to the cap on certain itemized deductions.
The Tax Policy Center (TPC) originally predicted, after all TCJA provisions were considered: “In general, higher income households would receive larger average tax cuts as a percentage of after-tax income, with the largest cuts as a share of income going to taxpayers in the 95th to 99th percentiles of the income distribution,” and “In total, for 2018, the average tax cut would be $1,600, with 80% of taxpayers receiving a tax cut averaging $2,100, but with 5% experiencing a tax increase averaging $2,800.” Here is what TPC expected by income group:
- Taxes would decline on average across all income groups.
- Taxpayers in the bottom quintile (those with income less than $25,000) would see an average tax cut of $60 (or 0.4%) of after-tax income.
- Taxpayers in the middle income quintile (those with income between about $49,000 and $86,000) would receive an average tax cut of about $900 (or 1.6%) of after-tax income.
- Taxpayers in the 95th to 99th income percentiles (those with income between about $308,000 and $733,000) would benefit the most as a share of after-tax income, with an average tax cut of about $13,500 (or 4.1%) of after-tax income.
- Taxpayers in the top 1% of income distribution (those with income more than $733,000) would receive an average cut of $51,000 (or 3.4%) of after-tax income.
IRS preliminary data for the 2018 tax return filing season for returns filed through May (after about 90% of returns have been filed, representing about 80% of taxable income) provides a sense of what actually happened (though, as of Dec. 15, 2019, we are still awaiting the final 2018 tax return data from the IRS, which will include the returns filed under extension):
- Aggregate total individual tax receipts came down about 6% from 2017 returns filed through the same period (May 2018) – $1,049 trillion and $1,114 trillion, respectively.
- The average tax per return (before payments) for 2018 (with or without any tax owed before payments) came down about 6% compared with 2017 returns filed through the same period – $7,780 and $ $8,304, respectively.
- The aggregate tax receipts as a percentage of aggregate AGI reported on 2018 returns filed through May 2019 came down 1.4 percentage points compared with 2017 returns filed through the same period – 11.9% of AGI for 2018 returns and 13.3% of AGI for 2017 returns).
- The average tax per return (before payments) for all 2018 returns filed through May that showed tax owed before payments came down by only $250 (or 2.3%) compared with 2017 returns filed through the same period – $10,684 and $10,934, respectively.
- The average tax (before payments) for taxpayers in the middle quintile ($50,000 to $100,000 of AGI) dropped $963 (or 13.7%) for 2018 returns filed through May 2019 compared with 2017 returns for the same period for an average tax of $6,044 on 2018 returns vs. $7,007 on 2017 returns.
- The average tax before payments for taxpayers in the lowest quintile ($1 to $25,000 of AGI) appears to have dropped only $6 for 2018 filings through May 2019 (less than 1%) when compared to 2017 returns of the same period: average tax of $890 for 2018 vs. $896 for 2017). When the lowest quintile for 2018 return filings through May 2019 was compared to all 2017 returns filed in this group through October 2018 (after extensions), the average 2017 tax for the group was actually $926, which would suggest the average 2018 tax for this group will fall by about $36 in the end. (This comparison still excludes the as yet unknown impact of potentially millions of lowest quintile taxpayers who filed a 2017 tax return but who no longer have to file.)
- Reliable data regarding the top 1% or top 20% for 2018 is not yet available due to the fact that most of the tax returns from these top income groups are under extension through October 2019. This could also impact the preliminary results for all quintile groups referenced above.
The above discussion regarding how much tax savings individuals experienced in 2018 as a result of tax reform ignores any offsetting impact of newly enacted and pending tariffs. Several nonpartisan authorities, such as Penn-Wharton and the Tax Foundation, estimate that over the next 10 years, the effect of tariffs will consume a significant portion of the tax savings as a best case, to almost all or more than the savings as a worst case. This was corroborated by the Federal Reserve Bank of New York in a May 2019 report, which estimated the total annual 2018 household cost of the current 10% tariffs on Chinese goods, ignoring other countries, was as high as $400. This could double to $800 per year if a proposed additional 15% on Chinese goods is enacted.
Make Taxes Lower Goal Achieved?
Yes. Every taxpayer knows the statutory rates were cut as well as the effective rate on pass-through business income of most taxpayers. However, the expected average savings may not come in as high as originally promised for many taxpayers due to other provisions that broadened the base of taxable income, and for some taxpayers, their taxes actually increased. Of course, any savings from tax reform is at risk of being offset by tariff costs that will be passed on to consumers. (Tariffs placed on products from a country of origin are not paid by that country. They are paid by the purchaser.)
Tax Relief for Small Businesses (So they can compete with larger ones)
As detailed above, the TCJA simplified small-business taxation. It expands qualifying small businesses’ ability to use simpler accounting methods; allows 100% immediate expensing on all new or used machinery and equipment; reduces the C corporation rate from 35% to 21% (applicable to all businesses, regardless of size); and adds a new deduction of up to 20% of qualifying pass-through business income, lowering the effective rate on such income down to as low as 29.6%.
Tax Relief for Small Businesses Goal Achieved?
Tax Relief for Multinational Businesses (So they can better compete with foreign ones)
The cut in the C corporation rate from 35% to 21% is a huge benefit to C corporations, as is the low-to-zero rate on offshore income earned. As a result, the new U.S. combined federal and state income tax burden after the TCJA has fallen from about 40% – highest among countries in the Organisation for Economic Co-operation and Development (OECD) and third-highest in the world – to about 25%. Compare this to the average statutory national and provincial rate for OECD countries of 28% (weighted for GDP), or 25% (nonweighted for GDP). The United States is no longer the highest in the OECD, but it is yet to be seen what impact this new rate will have in the long term as long as several developed countries still have a rate lower than the United States.
The effective tax rate – what is actually paid after using all available subsidies, credits, and loopholes in the code – is something else altogether. As a benchmark of what the effective rate was prior to the TCJA, a 2017 Congressional Budget Office (CBO) study found that the 2012 U.S. corporate marginal effective tax rate (federal and state rates on new investments) was only about 19%. It has been argued that this low rate shows that the United States’ high statutory rates among OECD countries was not that much of a true disadvantage after considering all the loopholes. However, the same study concluded that the 19% marginal effective rate was still fourth highest among the G20 countries because they too have built-in subsidies and “loopholes” that serve to lower statutory rates.
More recently, the Congressional Research Service (CRS) reported that the C corporation effective federal tax rate for 2017, the year before tax reform, was 17.2%. It turned out, based on Securities and Exchange Commission (SEC) filings for 2018, the effective C corporation federal rate came in at just 8.8%. Even when CRS backed out an estimate for foreign income, it calculated an effective U.S. federal tax rate of 23.4% for 2017 and 12.1% for 2018. This is almost a 50% decline in the effective rate, despite the statutory rate being cut by 40% and other base-broadening measures put in place to prevent this.
Readers may have come across the headline this past April, “Not Just Amazon: 60 Big Companies Paid $0 in Taxes under Trump Law.” According to this story in Yahoo Finance, which based its story on data from Fortune 500 public filings as reported by the Institute on Taxation and Economic Policy (ITEP), “In 2017, the effective corporate tax rate (for Fortune 500 companies) was 13.6%. In 2018, corporations paid just 7% of their profits as federal taxes. That’s the lowest effective tax rate since at least 1947.”
A separate analysis conducted by the Wall Street Journal published in July 2019 discovered that the median effective global tax rate for S&P 500 companies declined to 19.8% in the first quarter of 2019, compared with 25.5% two years earlier, and it was the third consecutive quarter below 20%. Although this reflects a higher effective rate than the other studies, it still represents an even lower rate than 21%.
This appears to have happened for several reasons. The TCJA continued many of the subsidies and loopholes that existed before tax reform (including base erosion loopholes, deductibility of stock options, 50% bonus expensing, and accelerated depreciation); it created additional subsidies, such as eliminating U.S. federal taxes on most post-2017 foreign profits; it increased bonus expensing to 100% and expanded it to include used personal property; and it provided for a low-to-no U.S. tax on foreign profits.
Therefore, it should not be a surprise that, according to the Peter G. Peterson Foundation, corporate tax receipts fell 31% in 2018, from $297 billion in fiscal year 2017 to $205 billion in fiscal year 2018, using U.S. Treasury available data. This data was also corroborated by the CRS. As of Dec. 15, 2019, the Treasury reports corporate income tax receipts have come in a bit higher, at about $230 billion for the fiscal year ended 2019.
Multinational Tax Relief Goal Achieved?
Yes, both from a statutory (stated) rate perspective and an effective rate perspective after continuing to take advantage of built-in subsidies and loopholes.
Businesses to Share Tax Savings with Workers through Increased Wages
When the TCJA was passed, the Trump administration and congressional leaders insisted that the tax savings for businesses would predominantly benefit workers. The Council of Economic Advisers estimated that 70% of business tax changes were expected to be shared with workers and increase annual wages for families by an average of $4,000, with the chair of the council predicting it could be as high as $9,000 annually. Note that several other studies at the time had predicted the opposite: that most of the tax savings would go to share buybacks and dividends.
In actuality, according to the Congressional Research Service (CRS) and based on Department of Labor statistics for 2018, average weekly wages of production and nonsupervisory workers had increased by about $22 (or 3%) to $766 in 2018 over 2017, or about $1,248 annually. Accounting for normal wage growth from inflation and normal productivity that would otherwise have occurred without tax reform, the real growth rate on wages was therefore only 1.2%.
One study from the National Bureau of Economic Research concluded that only about 4% of public companies announced that they would pay additional wages or bonuses due to tax reform. According to the CRS, although there was much press coverage about companies paying large bonuses around the time of the enactment of TCJA, one organization that tracks these bonuses, Americans for Tax Fairness, reported a total of $4.4 billion being paid in bonuses from the time of enactment in late 2017 through April 5, 2019. The CRS concluded that these bonuses amounted to only 2% to 3% of the corporate tax cut, “consistent with what most economists would expect that a small percentage of increased corporate profits or repatriated funds (if any) would be used to compensate workers,” and that “the bonus announcements could have reflected a desire to pay bonuses when they would be deducted at 35% rather than 21%, or the result of a tight labor market and attributed to the tax cut as a public relations move.”
Therefore, if the business tax savings did not substantially increase wages or bonuses to workers, where did it go? According to Americans for Tax Fairness, most of the tax savings seems to have funded a record-breaking amount of stock buybacks. Over $1 trillion in buybacks were announced by the end of 2018, which is similar to what happened in 2004 when a “tax holiday” on repatriated funds allowed firms to voluntarily bring back earnings at a lower rate.
Sharing Tax Savings with Workers Goal Achieved?
Allow Unprecedented Capital Expensing
As discussed above, it appears most of the tax savings funded share buybacks, not worker’s wages. But what about the goal of enticing capital investment?
The TCJA provided businesses with both a significant rate cut and a 100% immediate expensing of new or used machinery and equipment additions, as well as low-to-no tax on foreign earnings. Therefore, wouldn’t some of the tax savings have been reasonably expected to expand nonresidential fixed investments? The National Association of Business Economics (NABE) concluded earlier this year that tax reform did not impact capital investment. In fact, the NABE quarterly survey at the end of 2018 found that businesses reported less growth in sales, pricing, and profit margin; 84% of respondents claimed the TCJA did not change hiring or investment plans; and cash from the tax cut went primarily into buybacks, not capital investment and additional hiring.
The CRS reported recently that for 2018, although there was 7.5% growth in equipment purchases and 5% in structures, most of that growth occurred in the first half of 2018 and appears to be declining. The most reliable data would normally come from the U.S. Census Bureau’s Annual Capital Expenditures Survey Report, but the report for 2018 had not been released as of Dec. 15, 2019, and is not due out for another few months. I did find data from the Federal Reserve that tracks all capital expenditures for all economic sectors. According to this data, national total capital expenditures were $5.3 trillion on average for 2017, the year before the TCJA, increased to $5.7 trillion for 2018, and is at an annual pace of almost $5.9 trillion for 2019.
Capital Investment Goal Achieved?
Not to the extent originally envisioned. Although tax reform did allow for unprecedented levels of immediate expensing, a substantial rate cut, and a low-to-no tax on foreign earnings, these incentives did not produce long-lasting capital expensing behavior in the economy. This could be because, based on my experience, tax incentives alone do not drive capital expansion plans. Other challenges affecting these decisions include not having enough skilled and unskilled workers to operationalize additional capital expenditures into expanded or additional product lines; potential investments would not provide an adequate return compared with their cost of capital; and there may be too much uncertainty over future business conditions. For example, the already imposed and threatened tariffs by the United States and our trading partners are forcing businesses to evaluate numerous business-growth-affecting considerations: will they be able to pass on any tariff costs to consumers, creating inflation; where will consumers get the cash to afford the higher priced items; will U.S. and foreign consumers buy less due to price increases; and should businesses change suppliers to avoid new tariffs?
Update: Based on discussions with CEOs, I have found that other considerations include the time and effort to secure permits and the fact that the TCJA is not viewed as permanent (i.e., uncertainty as to what tax rates and incentives will be in just two years, especially if there is a Democratic sweep in 2020), which greatly affect the return on investment projections.
Establish More Permanence in the Tax Code
The TCJA provisions for individual taxation, including the 20% pass-through qualified business income deduction, all expire at the end of 2025. This crucial point is often overlooked. According to the Tax Foundation, this means, starting in 2026, almost all individual taxpayers will face a significant tax increase for which they have not planned. National politicians will be reluctant to allow this to happen, but no one knows what the political, economic, and fiscal debt climate will be at that time.
Unless Congress changes things, almost all business provisions will not expire (except for the 100% bonus expensing on machinery and equipment, and there are rate phase ins and outs in the way several base erosion provisions affecting multinational corps will be calculated). Of course, a new Congress after the 2020 election could make significant alterations to the rates and other TCJA changes if more revenues are needed and the political climate supports it.
Permanence in the Tax Code Goal Achieved?
No. Based on an understanding of the expiring provisions and the political reality of having a new Congress every two years and, potentially, a new president every four years, changes to the TCJA as it currently stands seems inevitable over the next decade, if not sooner.
Encourage Companies to Expand in the U.S. and Bring Back Jobs from Overseas
According to several sources that have tracked this issue, the TCJA provided a substantial new incentive to encourage companies not only to continue much of what they had already offshored to take advantage of lower labor costs, lower tax rates, and various base-erosion loopholes, but also to expand their efforts offshore. Specifically, instead of the prior treatment of taxing all foreign earnings at 35% (less applicable foreign tax credits) and instead of repealing the existing base-erosion loopholes, the new law does the following:
- The TCJA provides a new 100% dividend-received deduction on most active, operating income earned overseas that is within a normal rate of return of 10% of foreign invested tangible assets.
- It taxes the remaining foreign income at half the normal 21% or less (with foreign tax credits).
- It provides a deduction (foreign-derived intangible income, or FDII) for significant intangible assets located in the United States that generate revenue from foreign parties vs. U.S. holdings in tangible assets.
The new provisions above provide U.S. businesses with a significant incentive to increase their level of foreign operations, especially tangible assets. Despite some new base-erosion provisions (e.g., the Global Intangible Low Tax Income, or GILTI, tax of 10.5% on excess foreign profits above 10% of foreign tangible assets, and a Base Erosion Alternative Minimum Tax, or BEAT, on certain payments to foreign-related parties), the Tax Policy Center (TPC), the Institute on Taxation and Economic Policy (ITEP), and the Congressional Budget Office (CBO), have all concluded that the TCJA created net additional incentives for continued and expanded offshore profit shifting.
As one political commentator predicted, “Ultimately, many multinational corporations will pay little to nothing in U.S. taxes on their profits earned by shifting call centers and factories overseas.” It appears President Trump was surprised by this and has stated that this was not his intent. And, as it turned out, according to a new academic paper to be published soon, it appears that U.S. multinationals in fact did increase their capital investments overseas significantly more than they did in the United States.
Encourage Bringing Jobs Back from Overseas Goal Achieved?
Update: But then again, where would the workers come from if TCJA had been successful at substantially more U.S. domestic capital expansion? Update as of Dec. 15, 2019, I have a sense from my contacts with CEOs that they are very concerned about where to find workers.
Corporate “inversions” began in the 1980s when U.S. businesses relocated their headquarters to a foreign country to escape the high U.S. tax rates on the repatriation of earnings from foreign countries. After the inversion, companies would be able to repatriate foreign earnings at a lower rate in the parent company’s new foreign headquarters country.
Over the past seven years, the U.S. Congress and the Treasury issued several anti-inversion provisions. According to the CBO, as a result of this effort before tax reform legislation, the number of inversions slowed considerably from its peak several years ago. The TCJA subsequently added additional penalties to continue to discourage them after 2017. Although 2018 data is not yet available, the Congressional Research Service (CRS) believes the number of inversions is probably minimal given the lack of press releases on new inversion announcements.
Inversion Discouragement Goal Achieved?
Yes, but probably due more to pre-TCJA rule making.
Encourage Companies to Repatriate about $3 Trillion in Overseas Profits
Estimates of unrepatriated earnings held overseas by U.S. companies vary, but the commonly accepted amount of about $3 trillion can be traced to the Brookings Institute and ITEP. What is never mentioned by the media or politicians is that only about $1 trillion of this is held in cash according to a Federal Reserve study. It was always going to be impractical to expect U.S. multinational companies to liquidate or monetize investments in longer-term holdings, physical assets, and subsidiary holdings around the world that arose from previously reinvested earnings.
This $3 trillion amount had often been referred to as “trapped” prior to passage of the TCJA because the repatriation of those earnings would have resulted in a U.S. tax of 35%, less applicable foreign tax credits. The TCJA was supposed to incentivize companies to repatriate those funds by imposing a new, onetime lower rate on pre-2018 unrepatriated earnings: 15.5% on cash earnings and 8% on noncash earnings. The implicit promise was that these offshore funds would flow into the United States and be reinvested directly into capital investment, create new jobs, and increase worker wages.
What was misunderstood by the general public, in my opinion, was that the funds did not actually have to be repatriated to enjoy the low rate. The rate was assessed on whatever the company’s unrepatriated earnings were at the end of 2017, repatriated later or not. Furthermore, since that onetime tax was payable over eight years, there has been no urgency for U.S. businesses to repatriate their previously “trapped” earnings. On top of that, Congress did not require companies to actually reinvest those earnings and create more jobs to enjoy the lower rate.
According to the CRS, only $664 billion was actually repatriated in 2018, which would have been drawn from not just the pre-2018 estimate of $2.6 trillion “trapped,” but also from additional 2018 foreign earnings, most of which was now tax-exempt after the TCJA. Specifically, about $300 billion was repatriated in the first quarter of 2018, then $200 billion in the second quarter, then a bit under $100 billion in each of the last two quarters. (Compare this to the average $150 billion of annual dividends from foreign subsidiaries in the prior three years.)
And as discussed above, there is little evidence that repatriated funds were directly used by the U.S. parent company for capital reinvestment or U.S. job creation.
Overseas Profits Repatriated Goal Achieved?
No. A significant amount of cash did get repatriated, but it was only $550 billion more than the average annual historical repatriation, and was nowhere near the $3 trillion amount often mentioned.
Stimulate Additional Economic Growth and the Tax Cuts Would Pay for Themselves Over the Long Term
The Trump administration’s 2018 Economic Report claimed there would be about 3% growth of gross domestic product (GDP) annually over the long term after enactment for the TCJA. President Trump suggested up to 6% was possible, and that growth was going to enable for the tax cuts to pay for themselves and not add to the national debt.
According to the Bureau of Economic Analysis (BEA) and a recent Bloomberg summary of that analysis, the official real GDP growth rate for 2018 (the first full year of tax reform) came in at a revised annualized rate of 2.5% compared with the 2.9% originally reported. This is slower growth than 2017’s revised rate of 2.8%, but still better than the post-recession average of 2.3%. However, according to the Congressional Research Service (CRS), this level of growth is “relatively small,” and “the data appear to indicate that not enough growth occurred in the first year to cause the tax cut to pay for itself.” And for the second quarter 2019 just ended, BEA reported that real GDP has slowed down considerably to 2.1%, after coming in at 3.1% for the first quarter. As of Dec. 15, 2019, BEA had updated and revised data for 2019 as follows: GDP growth in the first quarter was 3%, fell to 2.0% in the second quarter, and came in at 2.1% for the third quarter.
How much GDP growth would be required to have the TCJA pay for itself? To have generated enough tax revenues in 2018 to offset the cost of the tax cut, the CRS concludes it would have taken a 6.7% GDP increase sustained over the long term. Instead, “the combination of projections and observed effects for 2018 suggests a feedback effect of 0.3% of GDP or less—which is 5% or less of the growth needed to fully offset the revenue loss from the act.” In a report released this past June, the Congressional Budget Office (CBO) projects that real GDP growth (inflation adjusted) for 2019 will only be 2.4%, with an annual average of only 1.8% over the next decade. (As of Dec. 15, 2019, the CBO’s most recent forecast was released in October, and it had GDP growth for 2019 coming in at 2.3%, and still had a 10-year forecast average of 1.8%.)
Since the GDP growth rate will not be good enough to pay for the tax cuts, what will be the impact on our annual deficits going forward? According to a CBO forecast issued in April 2018, shortly after enactment of the TCJA, tax reform was projected to add almost $2 trillion to our national debt over 10 years, including additional interest costs, further aggravating an already concerning level of national debt, the implications of which are beyond the scope of this article, but are real and are very serious.
This negative effect was felt quickly. For the 2018 fiscal year, which only had nine months of post-TCJA effects, a Treasury report issued last October indicated that the 2018 deficit was about $780 billion, a 17% increase from the prior year. This was primarily due to tax reform generating flat revenues (despite the approximate $50 billion increase in individual revenues from somewhat stronger GDP and employment growth), and an increase of $110 billion in spending, including $60 billion for higher interest costs.
With respect to the 2019 fiscal year, the most recent CBO forecast
is projecting the annual deficit to grow even more, up to almost $900 billion. President Trump’s own chair of the Council of Economic Advisors has said tax reform has not paid for itself
yet. (Update as of Dec. 15, 2019: The actual deficit for fiscal year ended Sept. 30, 2019, came in at $1 trillion.)
Sufficient GDP Growth for Tax Cuts to Pay for Themselves Goal Achieved?
I suspect readers who support the Trump administration will see metrics in this extensive five-part analysis that generally support their view that the TCJA is working, and will believe that more time is needed to realize its potential. Critics of the administration will conclude that most of the promises were not met, and the nation needs to revisit how to better grow the economy and reduce deficits.
I did not set out to change or corroborate anybody’s opinion of the president. All I hoped to achieve is to remind readers of the promises made, put forward the relevant metrics and results to date, cite generally accepted supporting and authoritative sources, and let you decide whether or not more tax policy changes are needed.
For what it’s worth, my own opinion (not that of the PICPA, the AICPA, Lehigh University, or any other organization I may be affiliated with), is that it is difficult to conclude anything other than that the TCJA has thus far lived up to only a few key promises: providing tax relief for individual taxpayers (especially if they own a small business); simplifying taxes for individuals who no longer have to file or are eligible for the higher standard deduction; providing even more tax relief for C corporations and multinational companies, avoiding a recession, and moderately stimulating capital expenditures. (But even these accomplishments may be threatened by tariff wars and the uncertainty of what may happen to the tax code under a new administration.)
However, by having failed thus far on the other promises, especially reinvestment of business tax savings and foreign “trapped” earnings into U.S. expansion and job growth, it appears to me that the TCJA has failed with regard to the two most important objectives: increasing GDP significantly and avoiding an increase in the federal debt. For the TCJA to be more successful in these areas, two things will have to happen: businesses must find a way to bring on skilled and unskilled workers so that their new capital from tax reform can be put to domestic capital spending and GDP growth; and we must wait until 2020 for more certainty about what will happen with our tax code.
For my final, overall verdict when considering the longer term, one could reasonably argue that the relief for those who are clearly benefiting from tax reform (businesses and higher income taxpayers) may not necessarily be the “fairest” policy over time when considering the insufficient reinvestment of tax savings into the economy, lack of skilled and unskilled labor, lack of significant economic growth, and potential impact of growing deficits. It is, therefore, difficult for me to conclude anything other than we will inevitably face higher and more burdensome income and payroll taxes, regardless of who wins in 2020, and that burden will fall especially on the wealthy and the middle class, and/or a new type of national tax will be created. Otherwise, we will soon experience reductions in infrastructure, defense, and climate remediation investments, as well as reductions in social safety nets that will affect all of us, directly or indirectly, particularly the middle class and those who are poor.
With an informed electorate and a wider base off support, perhaps a “Tax Reform 2.0” can be developed by whichever party is in control after 2020, with more focus on growing GDP while keeping these long term challenges in mind and without contributing to growing income inequality.
Robert Duquette, CPA, is Professor of Practice in the College of Business at Lehigh University, a member of the Griffin/Stevens & Lee Tax and Consulting Network, and a retired EY tax partner. He has served on PICPA’s Federal Taxation Committee for over 25 years, focusing on federal tax reform and the national debt.