June 15, 2008: Ten Years Ago at Grasping Reality

Yes: Last Fall the Unprofessional Republican Economists Were Lying About Corporate Taxes, Investment, and Growth. Why Do You Ask?

There were "economists" last fall telling us that the Trumpublican tax cut was going to raise real wages in America substantially and soon: Robert J. Barro, Michael J. Boskin, John Cogan, Douglas Holtz-Eakin, Glenn Hubbard, Lawrence B. Lindsey, Harvey S. Rosen, George P. Shultz, John. B. Taylor; Larry Lindsey and Douglas Holtz-Eakin; James Miller, Charlie Calomiris, Jagdish Bhagwati; Kevin Hassett; Greg Mankiw; and the others. The people who last fall were telling us that the Trumpublican tax cut was going to raise wages by boosting growth by a number they decided was 0.4% per year—get us an extra 80 billion dollars of prosperity each year growing over time—all did so by pointing to the investment channel: (a) the tax cut would make investment more profitable, (b) we would then have about 800 billion a year of extra investment, (c) the added production made possible by that investment would be 80 billion a year, (d) and eventually wages would rise. (a) has happened. (b) was supposed to take effect quickly—this year. But (b) has broken down: business investment "should" be jumping from 13% to 17% of total production. It is not. So far it has jumped from 12.4% to 13.1%—one-sixth of the jump we were promised:

Gross private domestic investment Domestic business FRED St Louis Fed

This comes as no surprise: Paul Krugman: Tax Cuts and Leprechauns: "The immediate effect of cutting the corporate tax rate... a big fall in taxes collected from corporations...

...Why give up this revenue? The story told by modern advocates of corporate tax cuts, like the Trump CEA and the Tax Foundation, hinges critically on... [how in] a global capital market... investment flows to whichever country offers the highest after-tax rates of return. So cutting the tax rate, according to this story, will bring in lots of capital from abroad. This will drive the rate of return down and wages up.... Is there good reason to believe that the tax cut will do what it promised even in the long run? Specifically, are international capital movements really all that sensitive to tax rates?... No, say [Ludvig Wier, Thomas Tørsløv, and] Gabriel Zucman.... Corporations... make profits appear in low-tax countries; but there’s very little real production or employment behind those profits.... Tax-haven countries... show... ridiculously high levels of profits relative to wages... because the profits aren’t being earned where they’re being reported.... Ireland....

But if Ireland hasn’t actually been attracting all that much real foreign investment, how do we explain the “Celtic tiger” growth rates it had for a number of years? The answer is that a lot of the growth isn’t real: it’s leprechaun economics, in which tax avoidance strategies produce fictitious growth.... It’s much less of a miracle than it seems, with real wages doing fine but nowhere nearly as well as measured productivity.... The supposed rationale for big corporate tax cuts is based on a misinterpretation of the evidence. Multinational corporations move profits–as reported—around based on tax considerations; actual capital, and hence actual economic activity, not so much.

But why aren’t actual capital movements that sensitive to tax rates?... [A] little secret.... Interest rates don’t have much direct effect on business investment. In fact, in general it’s hard to find any effect at all. Monetary policy works through housing and, these days, the exchange rate; if it affects business spending, the effect is indirect, through changes in sales that were caused by housing and the exchange rate. You can see what I’m talking about by looking at investment during the great slump of 1979-82, which was more or less deliberately engineered by the Fed to squeeze inflation down (Figure 6). Interest rates shot up, residential investment plunged, but nonresidential investment more or less kept plugging along:

Opinion Tax Cuts and Leprechauns Wonkish The New York Times

Why doesn’t business investment respond more to interest rates? Because many though not all business investments are relatively short-lived.... A business considering investing a dollar will compare the marginal product of that dollar’s worth of capital with a cost that includes both the cost of capital and the rate of depreciation.... Cutting the corporate tax rate reduces the effective cost of capital, which should encourage more investment. But given the relatively short lives of business investments, this effect should be fairly small. Tax cutting as a way to encourage investment is fairly ineffective for the same reasons that monetary policy has relatively little direct traction over business spending....

[Is] the case for cutting corporate tax rates is unadulterated nonsense? No, it’s adulterated nonsense. There’s some reason to believe that lower tax rates will, other things equal, have some positive effect on capital formation. But... there is no reason to believe that the kind of tax cut America just enacted will achieve much besides starving the government of revenue.

If any of have revisited this issue and admitted error or deception, I have not seen it