Tax Policy and Investment in a Global Economy
Gabriel Chodorow-Reich (Harvard University), Owen Zidar (Princeton University), and Eric Zwick (University of Chicago)
Business tax paper of the month - April 2024
The Tax Cuts and Jobs Act (TCJA) of 2017 marked the most substantial reduction in corporate taxes in U.S. history, lowering the top corporate tax rate from 35% to 21%, altering investment incentives, and changing the treatment of international income. Our paper, “Tax Policy and Investment in a Global Economy,” which is joint with Matthew Smith at the U.S. Treasury’s Office of Tax Analysis, evaluates the TCJA's corporate tax provisions using administrative tax data and a new global investment model.
The main findings include:
- Domestic investment of firms with the mean tax change increases 20% versus a no-change baseline.
- Novel international tax provisions incentivized U.S. multinationals to increase foreign tangible capital, which also stimulated domestic investment, indicating complementarity between foreign and domestic capital.
- In the model, the long-run effect on domestic capital in general equilibrium is 7%.
- Higher depreciation deductions largely offset additional labor and corporate tax revenue from capital accumulation. As a result, the total effect on tax revenue over ten years, which includes dynamic feedback from growth, is within 2p.p. of the mechanical effect of a 41% decline in corporate tax collections.
We develop a model of multinational firms operating under domestic and foreign taxes. The firm operates domestic and foreign production lines using domestic and foreign capital, which may be complements or substitutes in production, along with flexible inputs such as local labor and materials. The firm pays a rate τ on domestic source income and τ* on foreign source income and receives an investment subsidy Γ on domestic investment and Γ* on foreign investment. The domestic terms τ and Γ incorporate TCJA changes to the corporate tax rate and expensing of investment and the model collapses to the canonical framework for domestic-only firms. The foreign tax terms accommodate the novel, more opaque changes to the international tax regime such as a minimum tax of 10.5% on Global Intangible Low-Taxed Income (GILTI) and an export subsidy called Foreign-Derived Intangible Income (FDII), which reduces a firm’s domestic tax on the export share of income exceeding 10% of its domestic tangible assets.
We use the model to measure and characterize how the TCJA affects incentives to invest domestically and abroad. Using a panel of mid-size and large C-corporation tax returns from the U.S. Treasury, we measure firm-level empirical counterparts to each tax term. For firms that only operate domestically, the tax incentives for investment manifest in a single tax wedge, given by the ratio of the price of capital net of the cost-of-capital subsidy to the net-of-corporate-tax rate, i.e., the tax term (1-Γ)/(1-τ).
Motivated by the model structure, we estimate regressions in the cross-section of firms of the log change in domestic investment around the reform on the tax policy changes. We find significant responses to changes in both the domestic and international tax terms for both domestic and foreign capital of U.S. multinationals.
Figure 1 summarizes this relationship between investment growth around the TCJA to Domestic tax term changes (1-Γ)/(1-τ). It shows that firms that received larger tax cuts experienced larger investment growth from the years preceding the TCJA to the years following the TCJA.
Figure 1: Investment Growth and Tax Changes at the Firm-Level
We use the reduced-form elasticities to identify structural parameters and quantify the general equilibrium response of corporate capital to the TCJA. We find a 7.2% increase in domestic corporate capital in the long run. We then turn to evaluate the effects of major provisions in isolation, such as changes to the marginal effective tax rate, expensing, and the GILTI tax.
Figure 2: Effects on Aggregate Capital Accumulation
Furthermore, we assess the revenue consequences of the TCJA’s corporate provisions. We find a significant reduction in corporate tax revenue initially of around 40%. The overall effects on tax revenue over a ten-year period are similarly negative. Although labor income and personal income taxes increase gradually, they are largely offset by the elevated cost of investment incentives. Thus, although the TCJA boosted investment, it came at a large cost to the federal deficit.
Figure 3: Effects on Tax Revenue
We validate our main findings in three ways. First, we test and verify that the predicted foreign capital implications line up with actual data on foreign capital accumulation. Comparing the global investment of publicly-traded U.S. firms to a synthetically-matched group of similar non-U.S. firms, we find sharp relative increases in the investment of U.S. firms. Finally, we show that firms that had more exposure to the TCJA saw higher stock market returns from the period between the 2016 election and the law’s passage in late 2017.
In conclusion, this study offers a comprehensive analysis of the TCJA's effects on corporate investment, capital accumulation, and tax revenue, highlighting the importance of understanding both domestic and international factors in shaping how tax policy affects economic outcomes.
