Tax Cuts to Test GOP's Economic Pledges

By FeaturesDow Jones Newswires

The U.S. economy is about to become the proving ground for Republican tax-cutting ambitions.

President Donald Trump and congressional Republicans are betting their tax overhaul will jolt the economy after a long but slow recovery. A sharp cut in the corporate-tax rate is meant to spur business investment and hiring. A rewrite of taxation for international profits is meant to bring corporate funds home. Lower individual rates are meant to give households more money to spend or bolster their finances. Fewer breaks, in theory, would make the economy more efficient.

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Still, the case for faster growth is murky when looked at through the lens of history and no sure thing now. The 1960s and 1980s saw solid economic growth after Democrats and Republicans lowered individual and corporate rates. But U.S. growth languished in the 2000s after two rounds of tax cuts, and a tax increase on high-income households in 1993 didn't hamper a building economic boom.

This time, the Trump administration says growth of 3% or more is possible after more than a decade near 2%. The economy has already delivered faster growth in the second and third quarters. But there are significant headwinds, including an aging workforce marked by retiring baby boomers and puzzling sluggishness in worker productivity. Independent economists say the tax cuts wouldn't pay for themselves, driving deficits higher by $1 trillion over a decade even after accounting for stronger growth.

Though polls suggest households are skeptical of the tax plan, expectations in markets and among some companies couldn't be much higher. The Dow Jones Industrial Average has rocketed up nearly 5,000 points this year.

William Sandbrook, chief executive of U.S. Concrete Inc., a Texas-based supplier of ready-mix concrete, expects to invest in new trucks and facilities. "We're not going to dividend it back, and we're not going to do share buybacks," he said. "We can expand without increasing our leverage."

Other executives say tax changes would have little bearing on their investment or hiring decisions, saying growth is constrained more by their ability to find skilled workers than it is by high taxes.

"If we sense a business opportunity for us, whether the tax rate is at 35% or 21% isn't going to make a difference," said Bill Hutton, president of Titan Steel Corp., a Baltimore distributor and processor of steel products. "The converse is if there isn't a viable business opportunity, lowering the tax rate isn't going to create it out of thin air."

A December Wall Street Journal survey of private-sector economists showed 9 of 10 professional forecasters expect the tax plan to boost the U.S. growth rate in the next two years, with most seeing a modest increase. Forecasters are split over long-term effects, with nearly half saying growth will eventually return to or dip below its current pace.

The tax cut could boost growth two ways: by raising demand or raising supply. In the short run, by giving business and consumers more money, it could spur demand for equipment, homes and other goods. In the long run, by encouraging people to work more and businesses to invest more, it could permanently raise the economy's supply capacity by increasing the number of workers and their productivity.

As demand stimulus, the $1.5 trillion tax cut isn't very large, even as Mr. Trump has called it the biggest tax cut in history. It accounts for 0.1% of gross domestic product each year over a decade, ranking it seventh or eighth in U.S. history, estimates Ethan Harris, chief economist at Bank of America Merrill Lynch. Demand stimulus tends to be less effective at times like these, when businesses enjoy low borrowing costs, easy access to capital and an economy with low and declining unemployment.

The economy was in a different position in 1981, when President Ronald Reagan signed what Mr. Harris said were the largest tax cuts in the postwar period, cuts that lowered the top individual rate to 50% from 70%. The economy was in need of help again in 2001, when President George W. Bush lowered the top rate to 33% from 39.6%, after the tech-stock bubble drove the U.S. into a mild recession. The Fed started cutting short-term rates then, too.

Today, the economy is in the ninth of year of expansion, and the unemployment rate, at 4.1%, has fallen to a 17-year low. The Fed is raising rates and expects to continuing doing so into 2020.

For now, the tax plan appears unlikely to alter the Fed's strategy. Officials signaled last week they don't see a need to raise rates more aggressively to prevent new stimulus from overheating the economy, in part because of muted inflation pressures.

The Fed has raised its growth forecast to 2.5% from 2.1% for 2018 and nudged up projections by smaller amounts for the two years after that. But officials still expect long-run growth of 1.8%, even with the tax changes, a full percentage point less than Mr. Trump's advisers.

To deliver long-run growth, businesses would need to invest more in workers and equipment. So far, they're voicing a mix of caution and optimism.

Rising stocks and low interest rates "are all symptoms of an excess of liquidity," said Joel Shine, chief executive of Woodside Homes Inc., which builds homes in four Western states. "To theorize more liquidity will supercharge the U.S. economy? That's a tough argument to make."

He said lower corporate rates should make it more attractive for companies to locate operations in the U.S. On the other hand, changes in the tax code that decrease the potency of individuals' mortgage-interest deduction and curb breaks for state and local taxes could soften demand in high-tax metro areas.

"I don't get up in the morning and take my after-tax income and figure out how I'm going to spend it," Mr. Shine said. "That's driven more by whether you see opportunities to drive expansion in your product areas."

A corporate tax cut has been welcomed by telecommunications carriers, which are some of the nation's biggest spenders on infrastructure and make most of their money through U.S. sales. A provision that allows companies to immediately write down the full value of capital investments through 2022 would also lead to big savings in the near term. AT&T Inc. said it would increase its capital spending by $1 billion in 2018.

Home Depot Inc. expects to save about $1.6 billion with a lower tax rate, Chief Executive Craig Menear said this month. The home-improvement retailer said it would spend on previously stated investment goals, including e-commerce plans.

"With what might be left," Mr. Menear said in an interview, "we would look at if there are other uses, whether used for [share] buybacks or whatever the best form is to return it to shareholders."

--Drew FitzGerald and Sarah Nassauer contributed to this article.

Write to Nick Timiraos at nick.timiraos@wsj.com and Kate Davidson at kate.davidson@wsj.com

(END) Dow Jones Newswires

December 19, 2017 15:39 ET (20:39 GMT)