Tax reform’s full impact not known but early returns are promising

Economists will not know the full impact of last year’s tax reform bill for some time to come. This is because it takes a while for changes in corporate tax law to meaningfully impact behavior and decision-making.

Nevertheless, the early signs are encouraging, as capital outlays appear to be accelerating, at least relative to the previous trend.

{mosads}The two main changes on the corporate side of the economy were: one, the reduction in the statutory rate from 35 percent to 21 percent; and two, the full expensing of capital outlays for the next five years. Ostensibly, these changes were designed to lift investment spending.

In the case of the former, it should come in the form of more direct foreign investment. Lower rates should make it more attractive for companies to relocate or consider the U.S. their new home.

Furthermore, lower rates should halt corporate inversions and lessen the dead weight loss of firms employing whatever means necessary to reduce their effective tax rate. No doubt, this should, in theory anyway, lift capital spending, productivity and ultimately the demand of U.S. labor.

Judging from the survey data on capital outlays, there does seem to be a positive shift in trend. For example, the new orders subcomponent of the Institute for Supply Management (ISM) registered its highest reading for the current business cycle last December, just as the tax bill was being finalized.

This somewhat esoteric economic series is a leading indicator of the economy in general and capital spending in particular. In fact, it is one of the 10 variables used in the Conference Board’s popular Index of Leading Economic Indicators. Therefore, its trend is closely followed by many different investors.

What is so notable about the recent peak in new orders is how late that it has occurred in the business cycle. In the past, new orders almost always peaked in the first couple of years of the economic recovery. The series has never been this high so late in the business cycle and with the unemployment rate so low.

This unprecedented late-cycle jump strongly suggests that the stimulus from this supply-side fiscal induction is having a positive effect on capital outlays. In the traditionally seasonally soft first quarter, inflation-adjusted capital outlays as measured in the GDP accounts were up 9 percent from their level a year ago.

But more recent data show the three-month annualized change in durable goods orders — a proxy for investment spending — running at over a 24-percent pace.

Further evidence to suggest that the change in corporate tax policy is having its desired impact can be seen from an important survey of small businesses.

These are the firms that have less than 50 people — oftentimes much less than 50 people — and who account for roughly 40 percent of total U.S. employment. They are a key driver of the labor market and hence the broader economy.

Every month, the National Independent Federation of Independent Business (NFIB) sends out a member survey, asking them a slew of different questions as they relate to their business and the broader economy.

Post the tax bill, we saw both a record large increase and a record high percentage of small firms reporting that now is a good time to expand. This also dovetailed with a collapse in the percentage of small businesses who had reported that high taxes were their single most important problem.

In fact, this past March saw the smallest share of small businesses who had listed taxes as a concern in the history of the NFIB survey.

To be sure, the examples cited above were influenced by the change in tax policy. But, it is much too early to try and ascertain the exact magnitude. After all, there are many other considerations that go into a firm’s decision to spend money.

Some of the improvement in investment spending could be related to deregulation. Nonetheless, we are very encouraged by what we are seeing in the various data. And while the full impact of the tax bill may not be known until we are well into the next business cycle, the early results are encouraging.

Even though it is old in terms of years, the ongoing expansion may still have a lot more room to run.

Joseph LaVorgna is the chief economist for the Americas at Natixis, an international corporate and investment banking, asset management, insurance and financial services arm of Groupe BPCE, the 2nd-largest banking group in France.