Since the enactment of the Tax Cuts and Jobs Act (“TCJA”) in 2017, changes to the United States system of corporate taxation has gained more attention among policymakers and the public. Promised to be the solution to a stagnant economy, the TCJA was the largest tax overhaul in decades. My recent article, “Falling Short: The Unintended Consequences of the Corporate Tax Cuts,” analyzes the provisions added to the Tax Code by the TCJA, argues that the TCJA has failed to meet its goals with respect to corporate behavior and overall economic impact, and provides discrete recommendations for improvement.
Background
Policymakers intended to provide corporations with an immediate benefit in the form of a reduced corporate tax rate. Advocates of the lower rate predicted that the $1.5 trillion in tax cuts would increase gross domestic product (GDP) and investments, as well as workers’ wages and employment. In theory, this would produce a trickledown effect benefiting employees. Early projections indicated a larger economy, higher wages, and a drastic increase of new full-time equivalent jobs. Backing these predictions, the White House insisted the tax cuts would result in greater productively and wage growth of $4,000 to $9,000 per year for working Americans. Concerns of redistribution to shareholders were dismissed and the public was assured that the cuts would go directly to job creation and higher wages, while still maintaining revenue neutrality.[1] The tax cut was seen as a way to encourage corporations to invest, upgrade, expand, and hire.
Despite the goals of the corporate cuts, there is no evidence that the provisions of the TCJA produced any significant benefit to U.S. taxpayers or the economy.
Findings
By analyzing corporate provisions and statistics, it is apparent that the Act not only fell short of its goals, but also contributed to several adverse outcomes. These results are based on comparisons of corporate and economic behavior immediately prior to the TCJA with those numbers released in years after. Due to the drastic economic impact of COVID-19, data was not considered beyond the year 2019.
Lack of Economic Improvement
Due to the TCJA’s focus on improving the economy, the most significant overall shortcoming was the lack of economic improvement. Within the first year of enactment, the U.S. economy grew by 2.3 percent, slightly lower than the 2.4 percent rate of 2017. The next year, job growth was stable but weaker than just before the TCJA’s enactment, and the economy grew at the slowest pace since 2016. Consumer spending barely increased, which accounts for two-thirds of 2019’s total growth, and disposable income declined.
In 2018, corporations contributed 44 percent less to government revenue than the previous year but only three percent of working Americans received any form of wage increases or bonuses. Research into corporate spending of large public companies also shows that, despite the large savings to corporations, a typical worker only received an estimated $200 per year increase in salary. While some corporations were distributing their tax savings to employees, 81 percent said their plans for investing and hiring had not changed due to the TCJA. A second survey conducted a year later (in 2019) found that even fewer corporations were willing to adjust investment or hiring plans. Not only were corporations refusing to hire, but the 1,000 largest companies actually announced the elimination of nearly 140,000 jobs, of which 73,000 were newly created just before enactment.
The economy as a whole also failed to see any boost or benefit from the tax cuts. This is because access to cash should not directly affect corporate investment unless the corporation was already lacking liquidity. This was not the case for the majority of large U.S. corporations, with cash reserves totaling billions of dollars and easy access to credit. As such, it was unlikely that providing a slightly reduced tax liability would lead to drastic changes in corporate investment.
Insufficient Incentives for Domestic Corporations
To make the U.S. more competitive internationally, encourage domestic corporations, and retain revenue that would have been lost to more competitive rates, new international provisions were added within the TCJA. However, to date, there has been little response. With the fast-track passing of Foreign Derived Intangible Income (FDII), Base Erosion and Anti-Abuse Tax (BEAT), & Global Intangible Low-Taxed Income (GILTI), the provisions lack any significant incentives for U.S. corporations to move assets or change their behavior. In analyzing these provisions, it seems as though some arguably work against the lower tax rate and create new loopholes, encouraging corporations to keep their assets overseas. The same provisions that were designed to encourage corporate relocation of intangible assets back to the U.S. also created incentives for those corporations to acquire tangible assets elsewhere.
Before the TCJA, foreign income avoided taxation until it was repatriated back into the U.S. Over time, corporations began to shift ownership of highly profitable intangible assets to offshore subsidiaries with minimal tangible assets in low-tax countries as a way to avoid taxation. To combat this problem, the TCJA introduced GILTI, which allowed for the taxation of intangible income earned by foreign subsidiaries without impacting the accumulation of earnings abroad. In theory, this could effectively discourage intellectual property shifting; however, based on how GILTI is calculated, this actually encourages corporations to make foreign tangible investments as a way of reducing GILTI. The greater the value of tangible assets held overseas, the less income will be qualified for taxation.
Even with these attempted safeguards in place, the corporate tax rate is unlikely to meaningfully reduce corporate profit shifting. Despite the drastic rate cut, the TCJA only expected to reduce profit shifting to other jurisdictions by $65 billion over the next eleven years and to produce a net revenue gain of only $11 billion.[2] This result is mainly due to corporations shifting profits to countries with tax rates even lower that the new U.S. rate of 21 percent, allowing corporations to continue to benefit from reporting profits overseas. Another contributing factor is that foreign and domestic investments are not necessarily close substitutes for one another and may not be sensitive to these tax changes, making a low rate unlikely to alter corporate action.[3]
Repatriation attempts under the Act also failed. Similar to the repatriation holiday in 2004[4], the TCJA tried to bring $1 trillion in liquid assets back into the U.S. without success. This new provision allowed for payment over eight years of a one-time reduced rate tax. Results were disappointing with less than $300 billion repatriated in the first quarter and even less the following quarter.[5] The reduction in repatriation costs did little to encourage domestic investment and again provided more incentive for corporations to increase foreign investment and benefit from international tax incentives. Corporate activity since the enactment has shown that foreign capital expenditures have influenced the increase in investment rather than domestic capital expenditures—the opposite of what Congress intended. Those corporations with a high repatriation cost had a significantly greater increase in foreign property, plant and equipment (PPE) invested post-TCJA, with the same corporations experiencing no change domestically.
Record-Setting Stock Buybacks
One of the most noticeable consequences of the lower corporate rate was the drastic record-setting stock buybacks immediately following the TCJA’s enactment. Corporations gained access to an estimated $664 billion dollars that went directly to stock buybacks. Within the first year alone, S&P 500 companies spent a combined total of roughly $806 billion in buybacks, breaking the 2007 record. Corporate buybacks accounted for 68 percent of net income, with dividends making up another 41 percent. The following year, 91 Fortune 500 companies paid no federal taxes on income and 56 others paid less than 5 percent. Theoretically this means the federal government funded roughly $92 billion in corporate buybacks within the first year of the corporate tax cuts through lost revenue.
Corporations and their shareholders received a windfall in more ways than one. Approximately half of the TCJA provisions were projected to go directly toward benefiting millionaires with only a small fraction going toward those making less than $200,000. The top quartile of wealth saw a 2.2 percent reduction in taxes, whereas the bottom saw only 0.4 percent.[6] Those lacking the ability to invest not only missed out on the same benefit, but they also experienced the lack of economic stimulus created by the repatriated funds.
Increased Federal Deficit
A focal point of criticism of the TCJA has been the large net cost. In late 2017, before the Act’s passing, the House and Senate were advised that the draft legislation would increase the federal deficit by no more than $1.5 trillion over the next ten years. Contrary to that goal, the Treasury Department reported that the federal deficit for the Act’s first full fiscal year was $113 billion, a 17 percent increase from $666 billion to $779 billion. The same report showed a loss from corporate taxes of $92 billion, accounting for 82 percent of the increased deficit. Although future predictions vary, using current statistics, a range of $448 billion to $1 trillion is estimated to be added to the federal deficit over the next ten years. In total, under standard economic assumptions, by 2027, the debt increase will be between $1.9 trillion and $2.2 trillion taking into account economic growth.
The TCJA fell short of other projected outcomes as well. Before the tax cuts were considered, the Congressional Budget Office estimated that total revenues would be 18.1 percent of GDP in the 2018 fiscal year; with the TCJA, they were only 16.4 percent. Actual corporate income tax revenue that year was approximately 40 percent less. With further corporate revenue declines projected, only about one quarter of the ten-year revenue loss associated with the TCJA will be offset by economic growth. For just the corporate portion of the TCJA to meet its revenue- neutral promise, corporate profits would have to increase by 67 percent, earning $167 million more in pretax profits.
As this gap between revenue and government spending increases, the amount borrowed to keep the government running also increases. In 2018, the Treasury expected to borrow $1.338 trillion from global investors, 145 percent higher than the $546 billion borrowed the prior year and the largest amount borrowed since the U.S. economy struggled in 2010. With the total cost of the TCJA climbing, it is apparent that the Act is not fiscally responsible.
Uncertainty in the Tax Code
Not only did the TCJA fail in simplifying the tax code, but it actually created more complexity for corporate taxpayers and added expenses in its governance. Concerns about expensive long-term effects have led some to urge repeal of its provisions, while others are foregoing any movement until further clarification is available. With the majority of the policy goals and incentives focused on corporate behavior, the effects on individual taxpayers will largely be determined by domestic and international business activity.
Most of the TCJA’s provisions are far more complex than initially expected and require expensive and time-consuming changes from corporations. In addition to employing accountants and tax lawyers to assure compliance, there are also large administrative costs and ambiguity in actual application. With concerns centered around provisions being reversed in the future, corporations are hesitant to make the change.
The uncertainty caused by these new provisions also imposes administrative costs. Due to the overall complexity of the provisions and the gaps left in the drafting, numerous regulations must be drafted in order to fill holes in the Code. This requires reallocation of government resources and more complexities for Congress to oversee. In an attempt to fast-track its guidance, the IRS was forced to use its already limited budget to increase the workload from the TCJA and further delay previously planned regulatory efforts. The new TCJA regulations required a single provision to be analyzed against all other provisions in the Code in order to evaluate impacts on those other sections and ensure loopholes were not created and gaps were closed. As each provision is checked against all other provisions, more regulations might be needed. The IRS estimates the implementation will take several years at a cost of $397 million in additional funding and require approximately 1,734 additional full-time employees.[7] The administrative impact is not limited to the federal government; state and local governments may also have to reallocate resources in order to determine any changes in local tax liability for international corporations in order to comply with new legislation.
Conclusion
While the TCJA had laudable goals to increase corporate expansion and job creation, it failed in that it provided corporations the funds needed for such expansion without incentivizing the follow-through. The TCJA should have focused more on encouraging specific, desired corporate behavior. Here are my major suggestions:
At the very least, the TCJA should have expected the possibility that the new capital would be used in stock buybacks and included a penalty discouraging this behavior. In addition, to encourage job growth, corporations should receive tax benefits for not only creating jobs but for maintaining those jobs over time. Likewise, the Tax Code should incentivize domestic corporations by awarding those that keep profits and jobs in the U.S. instead of overseas. Corporations would not only be motivated to keep profits and jobs in the U.S. in order to qualify for these credits, but the effects of such action would also benefit the U.S. economy, increase long-term GDP, and encourage more corporate growth and investment. To combat the use of tax haven subsidiaries to significantly reduce or eliminate tax liability, one of the most prominent issues associated with American multinational corporations, a minimum global tax should be imposed. A minimum global tax would prevent corporations from completely eliminating all tax liability. Corporations should be liable for either their calculated tax at the corporate rate or a minimum rate applied to all global profits.
It is clear the TCJA fell short of its goals, allowing corporations to greatly benefit at the expense of working Americans with little to no significant impact on the economy. But, as corporate behavior and tax avoidance techniques are ever changing, so is the Tax Code. Only by incentivizing beneficial corporate conduct and closing loopholes can the Code achieve its goal.
Tatum Remely, is a J.D. Candidate 2021 at the University of Idaho, College of Law.
[1] Stephen J. Pieklik, Nathan S. Catanese, & Cory C. Omasta, Deducting Success: Congressional Policy Goals and the Tax Cuts and Jobs Act of 2017, 16 Pitt. Tax Rev. 2018, at 6-9.
[2] Ari Glogower & David Kamin, The Progressivity Rachet, 104 Minn. L. Rev. 1499, 1561-63 (2020).
[3] Id.
[4] Part of the American Jobs Creation Act which allowed 9,700 companies to bring overseas cash back into the U.S. at a rate of 5.25 percent.
[5] Table 4.2. U.S. International Transactions in Primary Income on Direct Investment, U.S. Bureau of Economic Analysis.
[6] Pieklik et al., supra, at 33.
[7] Pieklik et al., supra, at 12.
