How has the U.S. Tax Cuts and Jobs Act of 2017 changed corporate behavior? In addition to reducing the corporate income tax rate to a flat 21 percent from a high of 35 percent, the TCJA changed other important rules on earnings stripping, expensing and depreciating, net operating losses, and the taxation of foreign subsidiaries. These changes generally reduced the effective and marginal tax rates of U.S. corporations. Using the first set of post-TCJA 10-K reports, our analysis seeks to provide a preliminary assessment of the extent to which these benefits have motivated corporations to do what TCJA proponents hoped.
Those proponents predicted that the act would increase gross domestic product, stock prices, and wages. The thinking was that increased corporate cash flows would fund capital expenditures on research and plant and equipment, prompting rises in worker productivity and the marginal value created by each employee. This, in turn, would cause more hiring and higher compensation. Proponents also expected that corporations would take advantage of lower repatriation taxes to “onshore” cash held in foreign subsidiaries, creating benefits similar to those from a lower corporate income tax rate.
Our analysis examined how the change in effective tax rate affected measurable corporate behavior as reported in the first set of post-TCJA 10-K filings, which covered the 2018 corporate fiscal year. We considered the top 100 companies in the S&P 500, excluding financial companies and firms that had not filed 2018 annual results at the time of the study. To represent the period before the passage of the TCJA, we considered the change in both the effective tax rate from 2017 to 2018 and the effective tax rate calculated as an average from 2015, 2016, and 2017 to 2018. We then compared these changes with several dependent variables to determine the effect, if any, on corporate behavior. The 12 dependent variables against which the change in effective tax rate were tested are (1) number of employees; (2) dividends paid; (3) capital expenditures; (4) cash flow from operations; (5) market value; (6) capital expenditure ratio; (7) research and development ratio; (8) EBIT; (9) EBITDA; (10) total executive compensation; (11) CEO compensation; and (12) total value of shares repurchased.
As expected, the effective income tax rate decreased significantly within our group of corporations. Using the single year base of 2017, the mean and median decreases in effective tax rate were 5.8 percent and 4.5 percent, respectively, with 71 of 91 companies reporting a decrease in effective tax rate. Using the multi-year base of years 2015-2017, the mean and median decreases were even larger, 9.8 percent and 8.0 percent, respectively, with 72 of 91 companies experiencing a relative decrease in tax rate. The summary statistics for the corporate behaviors studied are contained in Tables 1 and 2 of the Appendix to our full article.
Our analysis reveals that few corporate behaviors were significantly affected by change in effective tax rate. This includes two specific corporate behaviors – number of employees and capital expenditure ratio – which TCJA proponents indicated would change due to decreased corporate tax rates. The only dependent variables showing any statistical significance were CEO compensation, using the single base year of 2017, and total value of shares repurchased, using the 2015-2017 average. This implies that the decrease in effective corporate tax rate bears little if any relationship to the indicia predicted by the law’s proponents, but may bear some relationship to both increased CEO compensation and total value of shares repurchased.
While our study has shown no evidence of corporate behavior generating widespread benefits of any kind, there are limitations to our analysis. We focused on only the largest, publicly-listed U.S. corporate entities. It is possible that smaller companies or private companies might behave differently than the corporations in our sample set. In addition, as this study was intended as a survey, we did not consider sub-sample analyses such as by corporate industry; there may be ways to further parse the data that could return different results. Also, our study considers only one year after the passage of the TCJA, which may be too soon for corporations to respond to decreased tax rates. Finally, different corporations could make accounting decisions that render comparisons of the type included here imperfect; different methods of managing data might produce different conclusions.
The TCJA cut taxes by $1.5 trillion, conferring significant tax benefits on U.S. corporations. Contrary to predictions of the TCJA’s proponents, however, economic growth has shown no sign of increasing to nearly the extent necessary for the tax cut to “pay for itself.” Due to the passage of the TCJA, as well as increases in discretionary spending passed contemporaneously, the United States now faces the largest federal budget deficit it has ever experienced during a period of peace and economic growth. While the long-term impacts of fiscal profligacy are as uncertain as the tax policy effects on economic growth, we should expect that a sizable reduction in federal tax revenue comes with some economic benefits to offset the burden of increased debt. Based on our study, we have not yet found any such benefits in the post-TCJA behavior of U.S. corporations.
This post comes to us from Nicholas Cohen, founder and principal of financial-services consulting firm LobbySeven, and Manoj Viswanathan, an associate professor at the University of California, Hastings College of the Law. It is based on their recent paper, “Corporate Behavior and the Tax Cuts and Jobs Act,” available here.