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GOP Tax Cuts and Economic Growth. Is There a Link?

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Note: This is an excerpt from the monthly Zacks Economic Outlook for October. You can read the full report here >>>

The Republican Party has unveiled its tax plan framework in the past month.

While details were left to Congress, it was blithely announced it would not benefit the wealthy. The new plan leaves rates on capital gains and dividends untouched, and leaves the top tax rate for individuals near its present level of 39.6%. However, the top 1% of households would benefit from the repeal of the estate tax and the elimination of the alternative minimum tax. Benefits to the middle class were announced as well, with gritty details to be determined.

While legislators still need to write some of the pieces of the plan (and the legislatures might not pass, as Democrats have almost universally opposed the plans), the heart and soul of the tax overhaul will be the lower tax rates on corporations and businesses. The Trump administration and GOP leaders argue that lower rates will contribute to stronger growth, which will ultimately benefit everyone and in particular ensure that the tax cuts will eventually pay for themselves.

The argument of trickle-down economics has a long history, i.e. lower tax rates for corporations and business benefit the entire economy through higher employment and higher wages. What is the empirical evidence?

Joel Slemrod, a University of Michigan economics professor examined data from the U.S. all the way back to 1870. He finds indications of a complicated relationship that do not provide evidence either way. Cross-country comparisons similarly do not indicate a strong relationship between tax cuts and subsequent growth periods.

On the other hand, Matthew Shapiro, also at the University of Michigan suggests that tax cuts could have short effects on business investments (which however fade over time). But that could be worthwhile too.

As Kevin Hassett, the new chairman of the Council of Economic Advisers indicated, a permanent increase in the growth rate will be very difficult. But a temporary increase might be enough to raise the standards of living.

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