The Macroeconomic Effects of Corporate Tax Reforms

TL;DR

The paper investigates why two major US corporate tax reforms—Kennedy's in the 1960s and the 2017 TCJA—produced very different macro outcomes. It develops a simple two-sector neoclassical model with explicit tax depreciation and pass-through firms to generate a corporate tax wedge that distorts investment, and it calibrates this framework to the US economy. Empirically, it documents modest aggregate stimulus from TCJA-17 but a large response within C-corporations and a reallocation from pass-throughs to C-corps, while Kennedy's cuts produced a stronger aggregate boost with little payout growth. The combination of depreciation policy and the share of pass-through activity explains the divergence, and the results suggest that the marginal effectiveness of further corporate tax cuts is limited when distortions have already been reduced.

Abstract

Using aggregate, sectoral, and firm-level data, this paper examines the effects of two major U.S. corporate tax cuts. The Tax Cuts and Jobs Act (TCJA-17) led to large shareholder payouts but modest aggregate stimulus, while Kennedy's 1960s tax cuts stimulated output and investment with minimal payout impact. To explain this divergence, I incorporate tax depreciation policy and a pass-through business sector into a neoclassical growth model. The model suggests that accelerated depreciation and a large pass-through share dampen stimulus from corporate tax rate reductions, and that Kennedy's cuts boosted output four times more per dollar of lost revenue than the TCJA-17.

Figures (19)

• Figure 1: Response of Macroeconomic Aggregates to the TCJA-17 Notes: GDP, consumption, investment and non-residential investment are in real terms. "Forecast" refers to the median forecast in the SPF, and the point forecast made by the CBO. The series "Without RE" shows corporate tax revenues adjusted to remove the effect of earnings repatriation - the details of the adjustment procedure are in \ref{['Appendix_Empirics_Repatriation']}. All values are normalized to $100$ in 2017.
• Figure 2: Response of C-Corporations to the TCJA-17 Notes: Perfectly-balanced panel of $\approx 800$ firms accounting for $\approx 25\%$ of non-residential investment and $\approx 15\%$ of employment. Data on employment and share repuchases come from Compustat and their forecasts are constructed by extrapolating their 2-year growth rate.
• Figure 3: Response of C-Corporations to the TCJA-17: IBES vs Compustat Notes: IBES comprises a perfectly-balanced panel of $\approx 800$ firms accounting for $\approx 25\%$ of non-residential investment and $\approx 15\%$ of employment.Compustat comprises a perfectly-balanced panel of $\approx 5000$ firms accounting for $\approx 50\%$ of non-residential investment and $\approx 30\%$ of employment.
• Figure 4: The Size and Evolution of the Pass-Through Sector Notes: Economic activity is measured by "Business Receipts" from publicly available aggregated tax returns from IRS SOI. Data before 1980 have been manually collected from scanned version of SOI's Business Income Tax Return Reports and Corporation Income Tax Return Reports.
• Figure 5: The Shift of Economic Activity from Pass-Through Businesses to C-Corporations Notes: All values are computed from publicly available IRS SOI aggregated tax returns. "Output" is measured by "Business Receipts". "Investment", which is not available for sole-proprietorships, is measured by capital expenditure and is computed as "Depreciable Assets" in year $t$ minus year $t-1$ plus "Depreciation" in year $t$. "Income Reported by Individuals" defined as the sum of "Ordinary Dividends" and "Qualified Dividends" for c-corporations, and as the sum of "Business or Profession Net Income" and "Partnership and S-Corporation Net Income" for pass-through businesses.

Theorems & Definitions (4)

• Proposition 1
• proof
• Proposition 2
• proof