When thinking about tax policy, economists usually distinguish between the short term and the long term. Although there may be temporary boosts to the economy in the short term through a tax cut due to rising incomes, changes in tax policy alter the incentives to work, save and invest, which which can produce benefits for long-term economic growth. New research finds that while the benefits of personal income tax cuts are often concentrated in the short term, corporate income tax cuts generate ‘large and persistent’ positive effects on the economy long-term.
The Tax Cuts and Jobs Act (TCJA) of 2017 permanently reduced the corporate statutory rate from 35% to 21%. However, most CJA provisions for individuals and businesses are due to expire after 2025. For example, full support for short-lived hardware and software will begin to phase out next year, meaning companies will no longer be able to fully deduct the costs of these investments. of their taxable income. The temporary nature of these arrangements suggests that the economic benefits are likely to be concentrated over a shorter time horizon.
With respect to corporate tax rate reductions, the motivation for this policy is specifically to change the long-term incentives for businesses to invest and boost productivity, rather than to stimulate the economy in the short term. However, many tax policy analyzes tend to focus only on short-term impacts, typically one to two years after a policy change. This will miss out on many of the positive effects on growth resulting from the reduction in the corporate tax rate.
In a new paper, a team of economists studied changes in US federal tax policy after World War II to estimate their long-term impacts, looking specifically at changes in average tax rates. For personal income tax cuts, they found large and significant effects on GDP in the first six quarters, but none after two years. But for the corporate income tax cuts, the short-term impacts on the economy were small while the long-term impacts were strong, peaking after eight years. Personal income tax changes had temporary effects on productivity and an insignificant effect on investment in research and development (R&D), while corporate tax cuts boosted investment in R&D and led to a sustained increase in productivity. The authors identified the innovation channel from these R&D investments as the main channel through which corporate tax cuts generate long-term growth.
Economists have also looked at how total employment and hours worked have changed in response to tax cuts. They found that for corporate tax cuts, the labor supply response was modest, while personal income tax cuts had a temporary impact on hours worked and less impact on employment. However, increases in investment and consumption following corporate tax cuts indicate that they raise overall labor income, consistent with other evidence on the effects of corporate tax on wages.
Overall, the evidence presented in this paper is broadly consistent with economic theory regarding corporate tax cuts: in the long run, they incentivize firms to invest in capital, especially R&D, which increases the productivity of their workers and increases their income. And these economic impacts are larger and more persistent than changes in personal income tax rates. Policymakers should continue to focus on longer-term impacts rather than emphasizing the short-term stimulative effects of tax cuts.