As a way to stimulate jobs and the economy, in December of 2017, Congress passed The Tax Cuts and Jobs Act (herein, the “Act”). But, since we are “allegedly” already at or near full employment, the Act is, mostly, needed to be a “wage growth”, rather than a “jobs” stimulus.
Despite pockets of good news in some retail spaces and cloud computing, the economy appears to be slowing, with the present economic cycle coming to an end. Even with the benefits of the Act, the last GDP print was down (quarter over quarter), consumer spending has moderated, wages are largely stagnant, we have reached nearly full employment, stock market indices are level to down for the year to date, and the yield curve, while steepening of late, has been flattening.
As the economy is nearing or at the end of a long economic cycle, and, is, otherwise, set to slow, the Act will, potentially, prolong the present economic cycle. While tax cuts may provide a short-term, or one-time “shot” to an economy, it is the new capex depreciation rules that could give the economy a more protracted and sustainable economic boost.
The accelerated, or bonus depreciation provision of the Act, is intended to encourage businesses to invest in buildings, equipment, and machinery (i.e. capex investments) as a way to stimulate the supply side of the economy through business spending that may, or could, lead to jobs- particularly in the manufacturing and raw materials production and supply sectors, and economy-wide wage growth. To understand this intention by Congress, and the potential results of companies spending en masse, first requires a short discussion of “supply side” and “demand side” tax philosophies and strategies.
Tax cuts can be used to stimulate demand by consumers or by businesses (or by both).
“Demand side” tax cuts are intended to encourage or empower consumers across the entire income scale, to spend. Such tax cuts are intended to put money into consumers’ pockets that they will spend, and, in turn, help businesses grow through sales, and, thus, encourage businesses, as a consequence, to invest in their businesses by hiring more people, and buying more equipment and machinery, and make other growth-oriented investments in their businesses, so that they can feed the growing demand. This, in turn, may lead to more jobs, and then even more and more demand.
Tax cuts designed to encourage business spending are known as “supply side” tax cuts- also referred to as “trickle down” economics (a term used by some- generally, Republicans- to describe why stimulating the supply side of the economy to spend to stimulate business demand, has the most effective multiplier effect for the economy, while used by others- generally Democrats- as a pejorative to indict tax cuts that are, allegedly, designed to only benefit the rich.
While supply side tax cuts are intended to spur business demand and spending, they are also intended (at least, this time) to encourage companies to share the benefits, the higher earnings, with employees, in the form of wage increases, thus, putting more money in employees’/consumers’ pockets and spurring consumer demand. But, to be sure, it is expected and hoped that businesses will not “only” give raises and salaries and “all” of their respective tax cut benefits to the demand side, but, rather also invest in internal “growth” initiatives to give the multiplicative benefit that supply side tax cuts should provide. Otherwise, lawmakers would give the tax cut directly to the demand side.
It is hardly a fear that businesses will share all of the wealth with employees.
Supply side tax cuts, or “trickle-down economics”, can work in one or both of the following ways to stimulate economic growth:
(i) Businesses receive a reduction of the corporate tax rate and invest earnings in their businesses in ways that lead to job growth in their own businesses and in supporting businesses, such as the vendors and support services they use. Moreover, it is hoped that increased earnings will lead to capital expenditures.
(ii) Reductions in the corporate tax rate can lead to higher salaries and profits for company principals and executives paid out of the higher bottom line as well as for shareholders of such companies, in the case of public companies, with the expectation that they will all spend their increased income in ways that stimulate the economy, such as by buying homes, cars, and boats, or taking vacations, going to ballgames, and eating at restaurants. These things create jobs in other industries to support the growing spending on these luxuries and necessities.
To evaluate the potential protracted economic benefit we could receive from the Act, there’s a two-part query:
Whether capex will happen en masse; and, if so, would it be a net positive or a net negative for the economy?
Will we get capex en masse?
We are in the late stage of a typical economic cycle. We’ve had low interest rates for multiple years, during which time businesses have had numerous opportunities to invest in capital equipment using low-cost capital. Businesses may be concerned about rising commodities costs, rising interest rates, and a stretched consumer, which may dis-incentivize investments in new capital equipment. Without a consumer at the end of the capex rainbow, even with a tax benefit, an investment could be a true loss. Businesses need a positive ROI, regardless of the accelerated depreciation. Available capital must flow to its best and most productive and most profitable use, or else it’s just money spent to offset other income in an overall loss.
If we do get capex en masse, what would it mean for the larger economy?
If businesses en masse engage in capex, it could mean more jobs, and, since unemployment is so low, higher wages which result in demand side stimuli and a circle of business spending, more jobs, higher wages, and more demand growth.
Capex en masse could also mean wage inflation, higher interest rates, and higher commodities prices in commodities used to build machinery and equipment and even buildings. Rising raw materials prices can push businesses’ normal input costs higher. So, while businesses, en masse, make capex investments, and take tax write-downs, they are also increasing the input costs for raw materials used in their respective normal courses of business. Companies could have trouble passing-through these costs to consumers in this Amazon era unless wages rise.
Perhaps, Congress should have made it a condition that purchases be made from U.S. manufacturers only, so as to ensure that the U.S. economy gets the benefits of capex (job and wage growth), sans, or along with, any increased commodities prices that businesses and consumers may suffer; otherwise overseas companies may get the orders, while U.S. consumers get higher commodities and consumer product prices.
There is a concern is that companies will use their capex-spend to buy technologies that make their respective businesses more efficient, causing a lesser need for employees, thus shrinking the employment base and bringing down wages. On the other hand, even if such technology is acquired, it would still create jobs for the companies who develop, manufacture and sell such technologies, though, jobs created by the latter example may be less sustainable than the former. Whether the former or later types of jobs created by the capex bonus depreciation rules are better, I will leave to statisticians and economists to debate.
Will capex lead to higher wages and stimulate demand, increasing GDP and business profits, thus creating more business investment and even more jobs and even higher wages, providing rocket fuel for the economy?
Will capex lead to more jobs by raising the labor force participation rate?
Will capex lead to higher energy costs for consumers?
Will capex cause higher input costs for businesses?
Will higher commodities prices from capex cause interest rates to go higher?
Will capex cause higher commodities prices and higher wages, causing higher interest rates?
Will the effect of capex that leads to rising commodities and rising interest rates be offset by higher wages and a stronger consumer?
Will capex occur en masse, or to any significant degree at all?
There are the known unknowns; and, for investors and business owners- a dilemma. Should businesses avoid investing in capex if the consumer is weakening, while interest rates and gas prices are rising- or will capex and wage increases be the best panacea for weakening consumer spending?
It’s also a dilemma for the Fed. Will capex spending en masse cause commodities and/or wages to rise, justifying the Fed raising its target rate to normalize interest rates and continue quantitative tightening to normalize its balance sheet, and manage a real estate bubble and a growing national debt, while also fighting inflation; or, will the Fed have to try to continue to make its case for higher interest rates without underlying evidence of significant growth in wages, while commodities prices, especially oil, rise, due to economy-wide capex stimulus?
It’s hard to know how capex en masse will affect the economy, if it happens. If it doesn’t, it’s hard to see from where further job growth, and any wage growth, and any economic growth will come.
- When President Trump took office, the unemployment rate was 4.7%. As of April, 2018, the unemployment rate is 3.9%.The unemployment rate at the time that the Act was passed by Congress was 4.1%.
- There are, of course, a variety of other factors that businesses consider when deciding to make investments, including decisions on new capital expenditures, that go beyond the perceived and expected strength of domestic consumers, including: strength and expected strength of foreign markets and foreign consumers; strength of a companies’ own industry; other taxes and tariffs related to the business, beside income taxes; and internal business issues, such as capital position and best use of available capital.
Neil S. Siskind, Esq., President
The Siskind Law Firm
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