Raising economic expectations with the “after-tax” reckon: President Trump’s corporate tax cut plan.

The series of documents published by the White House Council of Economic Advisers indicate that President Donald Trump’s Tax Reform will end up being his economic growth policy. The most persuasive pitch behind the corporate tax cut is that lowering taxes to corporations will foster economic investment thereby economic growth. Further, the political rhetoric refers to GDP growth estimates of a tax-cut-boosted 3 to 5 percent growth in the long run. In supporting the corporate tax cut, the White House Council of Economic Advisers presented both a theoretical framework and some empirical evidence of the effects of tax cuts on economic growth. Even though the evidence presented by the CEA is sound and right, after reading the document, any analyst would promptly notice that the story is incomplete and biased. In this blog post, I will briefly point to the incompleteness of White House CEA’s tax cut policy justification. Then, I will show that the alleged “substantial” empirical evidence meant to support the corporate tax-cut policy is insufficient as well as flawed. In third place, I will make some remarks on the relevance of the tax-cut as a fiscal policy tool in balance to the current limitation of monetary policy. Finally, I conclude that despite the short-term benefits of the corporate tax cut, such benefits are temporal as the new normal rate settles, and at the end of the day, given that tax policy cannot be optimized, setting expectations from the administration is a policy waste of time.

The very first policy instance that CEA stresses in its document is the fact that corporate tax cut does affect economic growth. Following CEA’s rationale of current economic conditions, the main obstacle to GDP growth rates above 2 percent is low rates of private fixed investment. CEA infers implicitly that the user cost of capital far exceeds profit rates. In other words, profit rates do not add up enough to cover for depreciation and wear off capital investments. Thus, if private investment depends on expected profit as well as depreciation, simply put I_t=I(π_t/(r_t+ δ)) where the numerator is profit, and the denominator is the user cost of capital (Real Interest rate plus depreciation), the quickest strategy to alter the equation is by increasing profit through lowering on fixed cost such as taxes. CEA’s rationale assumes correctly that no one can control depreciation of capital goods, and wrongly thinks that no one (including the Federal Reserve which faces serious limitations) can control real interest rate, currently.

CEA fetched some data from the Bureau of Economic Analysis to demonstrate that private sector Investment is showing concerning signals of exhaustion. The Council sees a “substantial” weakness in equipment and structures investments. More precisely, CEA remarks that both equipment and structure investment have declined since 2014. Indeed, both variables show a decline in levels of 2 and 4 percent respectively. However, and although CEA considers such decline worrisome, those decreases seem not extraordinary for the variables to develop truly policy concerns. In fairness, those variables have shown sharper decreases in the past. The adjective “substantial,” which justifies the corporate tax cut proposal, is fundamentally flawed.

The problem with the proposal is that “substantial” does not imply “significant” statistically speaking. In fact, when put in econometric perspective, one of those two declines does not appear to be statistically different from the mean. In other words, the two declines look perfectly as a natural variation within the normal business cycle. A simple one sample t-test will show the incorrectness of the “substantial” reading of the data. A negative .023 change (p=.062), in Private fixed investment in equipment (Non-Residential) from 2015 to 2016, is just on the verge of normal business (M=.027, SD=.097), when alpha level is set to .05. On the other hand, a negative .043 change (p=.013) in Private fixed investment for nonresidential structures stands out of the average change (M=.043, SD= .12), but still, it is too early to claim there is a substantial deacceleration of investments.

Thus, if the empirical data on investment do not support a change in tax policy, then the CEA tries to maneuver growth by policy expectations. Their statements and publications unveil the desire to influence agents’ economic behavior by reckoning with the “after-tax” condition of expected profit calculations. Naturally, the economic benefits of corporate tax cuts will run only in the short term as the new rate becomes the new normal. Therefore, the benefit of nominally increasing profits will just boost profit expectations in the short term while increasing the deficit in the long run. Ultimately, the problem of using tax reform as growth policy is that tax rates cannot be controlled for optimization. Unlike interest rate, for numerous reasons, governments do not utilize tax policy as a tool for influencing either markets or economic agents.

 

Gross Domestic Product in 2015: same tempo as in 2014.

Real GDP in the United States increased by 2.4 percent in 2015 when compared to 2014. This growth rate represents the same tempo as in 2014. Growth was pulled up mainly by Personal Consumption Expenditures, Nonresidential fixed Investments, Private Inventory Investment, State and local Governments, and Exports. Although these figures of economic growth may look sluggish for many analysts, the truth is that they encompass good news for the American economy as far as investments concerns. The fact that economic growth was pushed up by both Personal Consumption Expenditures and nonresidential fixed investments means that both business people and consumers are confident about future economic outlook.

Consumption and  Nonresidential Fixed Investments:

On one hand personal consumption expenditure reveals that people are spending and not holding back on economic plans. Such a situation, combined with recent data on household debt, shows household are in good stand not only for economic growth but also for absorbing unexpected economic shocks. Same intuition applies to businesses insofar as Nonresidential Fixed Investments grew considerable. Those Nonresidential Fixed Investments are the set of spending dedicated to improving and expanding business facilities. State and local state spending continue to bolster economic growth nationally proving public expenditures work out well for the economy.

Price Indexes have been dragging much of the GDP figures for the last year or so. Indeed, the price index for gross domestic purchases barely increased 0.4 percent during 2015. It is worth noting that in spite of deflationary pressures derived from low oil prices, the price index for purchases rose 1.2 percent in 2014.

On the quarterly basis, second estimates data for the last quarter of 2015 showed that the economy expanded at 1.0 percent (when compared 4Q2014 and 4Q2015). Unlike the year-round picture, the last quarter increases resulted mainly from residential fixed investments and federal government spending, whereas nonresidential fixed investments declined along with a decrease in private inventory investments.

“Core” inflation rate will have huge influence on monetary policy next month.

Second Estimates for real GDP growth in the United States indicate that the economy grew at 3.7 percent during the second quarter of 2015 after correcting by price change. The report from the Bureau of Economic Analysis informs that the change mainly derived from positive contribution of consumer spending, exports, and spending of state and local governments. These increases are said to have been offset by a deceleration in private inventory investment, federal government investment, and residential fixed investment. The revised figure for first quarter of 2015 went up from -0.7 percent to 0.6 percent.

Besides real GDP calculations stand the estimates for prices changes in goods and purchases made by American residents that the Bureau of Economic Analysis (BEA) does simultaneously to the calculations made by the Bureau of Labor Statistics (BLS). In this regard, this time around the second quarter, prices had a positive growth of roughly 1.6 percent, which the BEA reports was derived from an increase in both consumer prices, and prices paid by local and state governments. Please bear in mind that, in the first quarter of 2015, prices were said to have dragged down the GDP numbers since the index decreased by roughly 1.1 percent change.

H&M Store in Broadway NYC. By Catherine De Las Salas. Summer 2015.

H&M Store in Broadway NYC. By Catherine De Las Salas. Summer 2015.

These price changes are actually good news for the Federal Reserve System for whom a moderate upswing in inflation helps them to achieve their yearly monetary goal of 2.0 percent inflation rate. And for those of whom like to make economic forecast, these figures mount onto their analysis for determining whether or not the Federal Reserve will increase interest rates in September. So, although real GDP measures are certainly corrected for price changes, the BEA’s price index will -on its own- have huge influence on monetary policy options for the months to come.

Thus, relevant data nowadays stem from BEA’s “core” inflation rate, which is to say price change without food prices and energy prices. Indeed, when figures isolate energy and foods volatility, the measure of inflation reaches 1.8 percent change from the first quarter of 2015. These changes in prices and output rightly affect the wallet of American residents. Price changes, plus increases in output -which reflect decreases in unemployment rate- may take consumer and producers to edge up their spending, which was one of the factor behind positive change in real GDP growth as mentioned above. Then, whenever spending tends to accelerate beyond its capacity the Federal Reserve reacts with an increase in interests rates. Even though one could argue that such is not currently the case, given that data on capacity utilization clearly shows that the American Economy has room to further spending, the BEA’s “core” inflation will be the measure that could possible make Federal Reserve Officials think twice about interest rates.

So, the puzzle about what the Federal Reserve will end up doing next Federal Open Market Committee meeting is fourfold, and it will derive from the different sources of data: first, price change data from BEA, which BEA claims to be way more “accurate” than BLS’. GDP growth from BEA, which is calculated by correcting price changes with their own price index. Price change from BLS, which may vary from BEA’s calculations. And capacity utilization from the Federal Reserve, which is whom finally decides on interest rates changes.

Real US GDP increased 5.0 percent in the third quarter of 2014: BEA.

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Real Gross Domestic Product increased 5.0 percent in the third quarter of 2014, the US Bureau of Economic Analysis reported today January 22 of 2015. The largest contributor for its expansion was the Finance, insurance, real state, rental and leasing Industry with a significant 20% of the total value added to GDP during the third quarter of 2014. Real State and leasing industry contributed 13 percent while the Finance and Insurance contributed 7.4 percent. The actual change in Value Added of the Finance industry was 21.2 percent when compared to the second quarter 2014, from which it had grown previously only 6.0 percent. Real Value Added is a measure of an Industry’s contribution to GDP given in constant prices (2005) rather than current prices.

Value Added by Industry group as a Percentage of GDP during the third quarter of 2014 was largely driven by the Finance and Insurance Industry. The second contributors for total GDP Value Added were both manufacturing Industry as well as Professional and Business Services Industry, which both contributed with 12 percent each. The public sector contributed with 9 percent of the GDP Value Added for the third quarter 2014. Education and health care also bolstered GDP Value Added largely with 8 percent.

These data point out toward a more convincing signals of a solid path of United States GDP expansion. First quarter of 2014 posed many question about the strength of the economic recovery from the Great Recession.

Take a look at Real Value Added by Industry:

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Real Value Added by Mining industry augmented by 25.6 percent, which meant its largest increase since the fourth quarter of 2008. It contributed 3 percent of the 5% GDP increase.

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Utility Industry which contributed 2 percent out of the 5 percent GDP growth, showed a 18.2 percent change from the preceding period.

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Real Value Added by Construction industry registered a small 2.3 percent change during the third quarter of 2014. Construction as a whole industry enlarged by 4 percent the total GDP Value Added for the same period.

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Manufacturing barely changed with a small 0.5 percent from the second quarter of 2014, though it still made up 12 percent of the total Value Added to GDP for the third quarter 2014.

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Real Value Added by the Wholesale trade industry registered a 7.3 percent change from period before. Wholesale industry made up 6 percent of the third 2014 quarter change. (Learn more details on Wholesale trade industry during 2014)

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Retail trade industry changed 1.1 percent and contributed the 5 percent GDP change by 6 percent. (See more details on Retail trade Industry).

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Real Value Added by the Transportation and Warehousing Industry changed 6.7 from preceding period. Such increase represents 3 percent of the total GDP change of third quarter 2014 (Read more on industries related to oil).

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Information Industry contributed 5 percent to GDP growth during the third quarter 2014, which came out of a 6.4 percent change of Real Value Added from preceding period.

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Real State, Rental and Leasing also grew its Value by 4.4 percent from the preceding period. The entire industry, which includes Finance and Insurance contributed 21 percent.

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Real Value Added by the Professional and Business services Industry experienced a 5.3 percent change during the third quarter of 2014. Professional Services Industry’s Value Added as a percentage of the total GDP represented 12 percent.

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Education services and Health care industries accounted for 8 percent change of the total 5 percent GDP Value Added during third quarter 2014.

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Real Value Added by Arts, recreation, Food Services, Entertainment added value at 5.1 percent when compared to the period before the third quarter 2014. This Industry as a group made up 4 percent of the total value added to GDP for the same period.

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