7 - Taxes and Economic Growth

Summary

The 2017 US tax reform cut tax rates for C-corporations, expanded business equipment expensing, and cut marginal individual income tax rates. When those provisions are treated as permanent, a neoclassical model implies that their effects are that output per worker rises in the long run by around 5 percent for C-corporations, 3 percent for pass-through businesses, and 4 percent for the overall economy. Over ten years, the estimated boost to the growth rate of per capita GDP is about 0.2 percentage points a year. The cut in individual marginal income tax rates has a larger estimated short-run effect on economic growth, 0.9 percentage points per year for 2018–19. A measure of the tax wedge between C-corporate and pass-through forms fell from 60 percent in 1960 to 37 percent in 1986, to 22 percent in 1988, to 16 percent in 2017, and to 0 in 2018. The cumulative estimated positive effect on productivity is 16 percent. At the same time, there has been a negative trend in the C-corporate share of economic activity, reflecting shifts toward sectors that benefit less from C-corporate legal form and the enhanced attractiveness of pass-through alternatives, notably LLC-type partnerships.