President Trump in the Rose Garden. (Photo: AP)
Business investment, generally speaking, is good. When companies buy things like new buildings, machines, software, vehicles or intangible assets, it helps the economy in at least four ways. First, those new capital goods require new workers to use them, so this investment tends to go along with hiring. Second, the companies that create the new capital goods get a boost. Third, having more long-lasting, productive capital goods like buildings, machines and vehicles increases a society's overall productive power, raising wealth in the long run. And fourth, new capital goods often contain cutting-edge technology that increases productivity.
Governments use a variety of tools to push companies to invest more. Some of these tools are direct — for example governments let companies write off investments on their taxes. Some are indirect incentives that focus on trying to encourage people to buy the stocks and bonds of companies, in the hope that the companies will use that money to boost investment. This is one reason capital gains and dividends are taxed at a lower rate than ordinary income. Governments may also try to encourage investment by lowering the rate of tax on corporate profits — since capital goods are basically long-term profit-generating items, allowing companies to keep more of their profits makes capital goods more valuable.
The tax reform enacted by President Donald Trump and the Republican-controlled Congress in 2017 contained two main incentives. It cut the federal corporate tax rate substantially, from a top rate of 35 percent to a top rate of 21 percent. And it let companies expense their investments immediately, instead of piecemeal over a period of years, for the next five years. Theoretically, investment should rise as a result. On the other hand, the reform also switched the U.S. to a so-called worldwide tax system, which could encourage companies to ship operations overseas instead of investing at home.
The effect of the tax reform is really an empirical question. It's possible that instead of buying new capital equipment, companies will respond to their tax cut windfall by returning the money to their investors, either with dividends or with share buybacks. Returning money to investors isn't a great sign, because it means that companies don't have any good ideas for ways to deploy their money to generate long-term profits. It can also increase inequality. Investors might plow their dividends and capital gains back into the markets, where it may raise business investment eventually, or they can spend the money on yachts or mansions or whatever it is that rich people buy these days.
So which is actually happening? Only one-quarter of data has been released since the tax cut was passed. In that time, business investment edged up to an all-time high:
But as a percent of the economy, it's not very large — still below the post-recession peak set in 2015:
Theoretically, an investment-driven boom should make capital expenditure a larger piece of the economy.
