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A store that is closing in downtown El Paso, Texas.
AFP via Getty Images
While President Trump and Congress have been engaged in a fruitless four-month negotiation of additional stimulus, the U.S. economy has been quietly roaring back to life.
In the third quarter, the economy grew at an annual rate of 33.1%—a record that would nearly offset the record decline of 31.4% in the second quarter (real GDP is now back to the level it was at in the first quarter of 2018).
Even more impressive, third-quarter real private investment grew at an annual rate of 83.0%, primarily driven by a 70.1% increase in equipment investment (returning to its second-quarter 2018 level).
Read: Record 33% GDP surge still leaves the U.S. economy in a world of hurt
On the job front, slightly more than half of the 22 million jobs lost in March and April have been regained, a dramatic improvement that nonetheless points to a long process of recovery for the labor market.
More than half of the jobs lost since the coronavirus crisis began have been recovered.
Bureau of Labor Statistics, “Employment by industry, seasonally adjusted.”
That the U.S. economy has recovered so much lost ground so quickly can be attributed to multiple factors, including policy moves made early in the crisis that bolstered liquidity and consumption, such as elements of the CARES Act and the accommodative policy by the Federal Reserve as well as the partial re-openings that have occurred in many states. And certain U.S. companies in the tech sector and elsewhere were well poised to address the changing needs of U.S. consumers.
One underappreciated factor may be the Tax Cuts and Jobs Act (TCJA), which instituted a number of pro-growth measures including a reduction in the corporate tax rate from 35% to 21% beginning in 2018, substantially reducing the tax burden on business investment and boosting after-tax earnings.
Reversing these tax cuts at a time when the economy has not yet fully healed, as the Biden campaign has proposed, would be a mistake.
At the time of its passage, the Tax Foundation forecasted that the TCJA would boost GDP growth by nearly a half percentage point in 2020, largely due to a multiyear process beginning in 2018 of building up the capital stock in response to a lower marginal tax rate on capital, leading to a more productive and more highly paid workforce. This marginal effect still works even now that investment plans for many businesses have radically changed in light of the pandemic (for example, retailers needed to suddenly build out the capability to sell remotely and deliver); the TCJA made more of those new investment plans viable.
Read Howard Gold: It’s official: The Trump tax cuts were a bust
Perhaps as important to the economic recovery this year has been the TCJA’s boost to corporate after-tax earnings and liquidity leading up to the pandemic, which allowed companies to pay down debt and improve their financial position.
This was largely due to the lower corporate tax rate and changes to the international tax system that reduced the incentive to keep earnings abroad, leading to a sharp increase in repatriation, the process by which companies bring overseas earnings back to the United States.
TCJA changes led to an increase in corporations repatriating funds
Bureau of Economic Analysis, “Table 4.2 U.S. International Transactions in Primary Income on Direct Investment.”
The earnings of S&P 500 companies rose 22.7% in 2018, the first full year the TCJA went into effect, and essentially remained at that level in 2019. The higher level of earnings allowed companies to maintain a healthy ratio of earnings to interest expense despite higher levels of debt.
Earnings fell during the pandemic and are expected to recover in the next few years
Yardeni Research
S&P 500 earnings this year are expected to fall 20% in the wake of the pandemic before rebounding 27% next year to about the same level of 2019.
The rebound in earnings and the broader economy is good news in that it appears to be staving off the anticipated “wave of bankruptcies” related to the pandemic and its aftermath, at least for big companies. While there were a number of high-profile corporate bankruptcies earlier in the year, the default rate has trended down over the last three months.
The economy is recovering strongly but it is not yet out of the woods. The latest bankruptcy filings through September indicate an uptick for small businesses, and many expect an increase given the lapse in federal aid. The latest unemployment numbers indicate many households are still struggling.
All of this suggests that further fiscal relief should be targeted accordingly, and the tax increases proposed by Biden, especially on business investment and labor, should be off the table until the economy is fully recovered.
Will McBride is the vice president of federal tax and economic policy at the Tax Foundation, a nonprofit think tank in Washington, D.C.
