The GOP's Tax-Cut Narrative Is Already Unraveling

The law’s role in boosting wages was overblown. Its deficits are scaring investors. And fears that it might accelerate inflation could push the Federal Reserve to choke off growth.

President Donald Trump smiling while Paul Ryan and Mitch McConnell clap
President Donald Trump, House Speaker Paul Ryan, and Senate Majority Leader Mitch McConnell at the Capitol (Joshua Roberts / Reuters)

The big Republican tax cut isn’t even three months old yet. But it’s already confounding.

For months, critics (like me) predicted that the new law would be a handout for large corporations, which would drive up their stock prices and enrich wealthy investors. Instead, the stock market has been a riot of volatility since Trump signed the tax cut into law. Many (myself included) predicted that companies wouldn’t pass on their fresh lucre to workers. Instead, several big firms celebrated the new law by publicly announcing a parade of bonuses and raises for workers. On top of that, wage growth in January accelerated to its highest level since the recession. The critics predicted rising stocks and flat wages. But reality seemed to deliver flat stocks and rising wages.

But, wait, maybe that narrative has got it all wrong. The most basic criticism of the GOP’s tax cut was that the boons for corporations and their shareholders would far outweigh the benefits for ordinary workers. That’s exactly what seems to be happening. Stock buybacks announced between January 1st and February 15th reached historically high levels, totaling about $170 billion in that period. That’s 28 times larger than the total value of end-of-year bonuses that were credited to the corporate tax bill—some of which had been announced months earlier and had nothing to do with the tax cuts. Companies might be advertising new bonuses. But they’re quietly reaping the benefits of higher profits.

There is, as well, a third possibility: The corporate tax cut might actually endanger Wall Street’s winning streak. When the Dow Jones plummeted by more than 1,000 points twice within a week in February, many analysts interpreted the flight from equities as a sign of fear—fear of inflation, fear of deficits, and fear of expedited rate hikes from the Federal Reserve. Where did that sudden fear come from? Some analysts point to the corporate tax bill, which injects hundreds of billions of dollars into the U.S. economy, buoying inflation, raising the deficit, and encouraging the Federal Reserve to raise rates accordingly. Just yesterday, stocks fell and the dollar rose after Federal Reserve Chairman Jerome Powell said the tax cut should boost consumer spending and increase productivity by making businesses invest in more technology.

In sum, the GOP tax cut is raising wages (except it isn’t); it’s good for stocks (except the market has been a nauseous mess all year); and it’s poised to grow the economy—so much so that the Fed is determined to choke off inflation and discourage more business investment, which will hurt economic growth.

If this is beginning to sound confusing, perhaps that’s because, well, it is confusing. Nothing like this has happened before—a massive, deficit-busting tax cut on capital during a period of steady growth and nearly full employment.

Economic historians can’t easily predict what’s going to happen because big rich countries practically never do what Republicans just did. The closest parallel in modern American history may be the early 1980s. Facing a deep recession in the midst of the Cold War, Ronald Reagan and the GOP slashed taxes and expanded military spending. When the economy recovered, the deficit bloomed and domestic spending increased. As the dollar strengthened, Americans bought more foreign goods than domestic goods. This created what the economist Martin Feldstein called the “twin deficits”—the budget deficit grew, of course, but so did the trade deficit.

Could that happen again? Maybe. But there is another possibility. Since the Republican tax cut effectively lowers the price of capital but not labor, it encourages large companies to invest in more buildings and technology. That could boost productivity growth, since a fixed number of workers plus a rising stock of capital should theoretically improve per-worker output.

It all adds up to this: The GOP law was always an enduring corporate tax cut advertised as fast middle-class tax relief. But because it represents a novel fiscal experiment, it’s not entirely clear what the short-term or long-term implications of the plan will be. If I wrote, “The GOP tax cut is essentially a discount coupon for technology that will raise corporate profits at the expense of labor in the long run,” I’d be telling a reasonable story. If I wrote, “The GOP tax cut is an inflation machine that will raise the price of goods and labor and encourage the Fed to raise rates accordingly, thus punishing corporate profits,” I’d also be telling a reasonable story.

Critics weren’t wrong in 2017 to say that the tax cut would exacerbate inequality, helping rich investors at the expense of workers. But the Republican tax plan is a radical and unprecedented experiment in fiscal policy, and time tends to make a mockery of certainty.