Tax Reform Boosts Capital Investments and Productivity

Higher investment contributes to labor productivity growth and wage increase, says Hassett
April 23, 2018 Updated: April 29, 2018

WASHINGTON—The new tax code is beginning to bear fruit, boosting capital investment that will eventually benefit workers, according to Kevin Hassett, chairman of the White House Council of Economic Advisers.

“I expect that—when we get the after-tax income distribution data for this year—income inequality will go down,” said Hassett at the Institute of International Finance Washington Policy Summit on April 19.

“The blue collar wages are surging right now, and the capital formation is taking off,” he said.

Capital formation refers to net additions of capital stock, such as equipment, tools, transportation assets, and electricity that are used in producing goods and services.

The massive amount of corporate capital, as well as record low unemployment, are creating a perfect environment for wage growth.
— Kevin Hassett, chairman of the White House Council of Economic Advisers

As various studies show, capital formation benefits workers, said Hassett. He believes tax cut savings drive up investment and profits, improve productivity and wages, and ultimately boost economic growth.

The tax reform passed in December reduces the corporate income tax rate from 35 percent to 21 percent. In addition, it allows companies to deduct 100 percent of the cost of their capital investments in the year the investment is made.

Critics of the tax reform claim that most companies will pass on the tax windfall to shareholders. Businesses, however, have accelerated their capital investments in recent months thanks to tax cuts and the full expensing provision.

Nonresidential fixed investment rose 6.3 percent year-on-year during the fourth quarter of 2017, according to the Bureau of Economic Analysis. Equipment investment increased 8.9 percent during the same period.

According to Morgan Stanley’s composite capital expenditure plans (CapEx) index, future capital investment plans of U.S. companies have also surged. The six-month CapEx plans index reached a reading of 35.4 in March, hitting the highest level in 13 years.

The index, which provides an approximate three-month lead time for growth in equipment spending, shows strong momentum in investment through the second quarter of 2018, stated a Morgan Stanley report.

“While the headline of some of the regional manufacturing surveys was hit by uncertainty over tariffs, plans for future investment appear to have been unscathed in March. This may imply that tax benefits are outweighing uncertainties over policy risk,” the report said.

Labor Productivity Improves

Capital investment raises capital per worker, a situation called capital deepening, which increases labor productivity. Early signs of labor productivity are also positive.

In President Barack Obama’s second term, capital deepening’s contribution to labor productivity growth in the private sector turned negative for the first time in U.S. history, said Hassett.

That means depreciation exceeded the investments in the country. That situation has completely turned around under the Trump administration, he explained.

Capital added 0.3 percentage points to productivity growth in 2017 and will continue to contribute more this year, according to Hassett.

For many years, U.S. corporations have left cash in their foreign subsidiaries to avoid high taxes. The tax reform addresses that problem by providing to American corporations a low repatriation tax rate, encouraging them to bring their overseas cash back to the country.

This change, along with corporate tax cuts, provides a strong incentive for American corporations to invest in the country, which will eventually benefit U.S. workers. According to estimates by the Council of Economic Advisers, households on average will get a $4,000 wage increase from corporate tax reform once the changes are fully implemented.

The massive amount of corporate capital, as well as record low unemployment, are creating a perfect environment for wage growth, Hassett said.

 

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