A Decline in Capital Investment Reveals the False Promise of Trump’s Tax Bill
With Donald Trump using his Twitter feed as a flamethrower on a daily basis, other significant developments, particularly policy ones, often don’t get the attention they deserve. Take last week’s G.D.P. report from the Commerce Department, which detailed a sharp slowdown in capital spending by American businesses during the second quarter of this year. To understand the full significance of this development, you need to go back to the first year of the Trump Administration.
In October, 2017, the White House Council of Economic Advisers published a white paper that claimed the Administration’s proposal to slash the tax rate on corporate profits would increase the average household income by at least four thousand dollars a year, and perhaps as much as nine thousand dollars. To say the least, it wasn’t entirely clear how presenting corporations with such a gift would generate this huge boost in living standards, but Kevin Hassett, a conservative economist who was the head of the council, suggested one possible route. “I would expect capital spending to really take off if the tax bill passes,” he told the Washington Post.
Hassett’s prediction was certainly a bold one. At the end of 2017, Congress passed a bill cutting the corporate-tax rate from thirty-five per cent to twenty-one per cent. The legislation also contained a second element designed to boost capital investment: it allowed businesses to deduct the cost of certain types of capital spending all at once in their tax returns rather than spreading the cost throughout a number of years. As businesses equipped American workers with the latest machinery and information technology, the workers would become more productive, and their wages would rise. That was Hassett’s theory, anyway, and a number of other conservative economists espoused it, too.
It didn’t take long for the White House to claim that the tax bill had worked. This time last year, Trump pointed out that private-business investment was rising at an annual rate of more than nine per cent. “So that’s a very tremendous increase,” he said. “There hasn’t been an increase like that in many, many years—decades. And I think the most important thing, and Larry Kudlow”—the director of the National Economic Council—“just confirmed to me, along with Kevin Hassett, that these numbers are very, very sustainable. This isn’t a one-time shot.”
As usual, Trump was exaggerating. The upturn in business investment during the first half of last year was by no means unprecedented, but it did represent an increase on the previous few years. However, it was fleeting. In the second half of last year, the growth in business investment fell sharply, and the slowdown has continued into 2019. During the second quarter of this year, according to last week’s G.D.P. report from the Commerce Department, it turned negative. If you exclude investment in residential real estate, which also fell, business-fixed investment declined at an annual rate of 0.6 per cent in three months, from April to June.
So much for sustainability. Barely a year and a half after the historic cut in corporate taxes, at least some businesses appear to be cutting back on their capital spending rather than increasing it. The softness in the second quarter was spread across all the major categories of business investment: structures, equipment, and software. Residential investment, which is usually considered as a separate category, fell as well. None of this was predicted in the White House script.
To be sure, the new figures are for just one quarter, and the quarterly G.D.P. data bounces around quite a bit. It seems likely that, in the coming months, businesses will step up their capital spending, at least somewhat. When the over-all economy is expanding, as it is now, firms need to invest to keep up with rising demand: outright falls in capital spending are rare. But even taking a longer-term perspective, there is little sign of the broad-based investment boom that the Trump Administration was predicting, or of the surge in household income that was supposed to accompany it.
Taking the two and a half years of the Trump Administration as a whole, business investment has expanded at an annual rate of about five per cent. That is a step up from the last few years of the Obama Administration, when a slide in oil prices led to big cutbacks in the capital-intensive energy industry, which previously had been expanding at a rapid clip. In 2017 and 2018, the first two years of the Trump Administration, oil prices recovered, and so did capital spending in the energy industry.
Many economists believe that, if you want to get a proper sense of the underlying trend in over-all business spending, it makes sense to strip out the volatile energy industry. After the Commerce Department released the second-quarter G.D.P. report, which included extensive data revisions going back to 2014, Jason Furman, a Harvard economist who headed the Council of Economic Advisers in the second Obama Administration, did the math and posted some of it on Twitter.
Furman looked at business-fixed investment, excluding spending on equipment and structures in the oil-and-gas industry. From the fourth quarter of 2013 to the fourth quarter of 2016, this measure of investment expanded at an annual rate of 4.6 per cent, Furman found, and from the fourth quarter of 2016, when Trump was elected, to June of this year, it expanded at an annual rate of 4.2 per cent. According to these figures, at least, business investment grew faster under Barack Obama. “It turns out investment growth was a little stronger before 2016 than we had realized and a bit weaker since 2017 than we had realized,” Furman wrote to me in an e-mail. “As a result, the entire increase in investment is due to rising oil prices leading to more investment in the oil and gas sector. Excluding that sector, business investment has slowed slightly.”
Of course, this isn’t the final judgment on the tax bill. In a blog post about the second-quarter G.D.P. figures, the current members of the Council of Economic Advisers argued that much of the weakness in business investment could be attributed to the problems of one company: Boeing, which has been forced to scale back production of its 737 Max aircraft. Other economists have attributed the recent weakness in capital spending to uncertainty about the U.S.-China trade dispute.
In analyzing the results of a big change in policy, such as the Trump-G.O.P. tax bill, it makes sense to overlook temporary ups and downs, and concentrate on longer-term trends. Arguably, we don’t have enough data yet to reach a definitive conclusion. But the early results have been disappointing. So far, they strongly favor the skeptics who argued back in 2017 that the White House and its supporters were grossly exaggerating the benefits that the tax bill would deliver.
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