Small business optimism in the US recently soared to its highest level since 2004, thanks in part to Donald Trump’s tax cut promises.
These US businesses may believe tax cuts will boost the overall economy, including companies of all sizes. But a new note by Credit Suisse’s James Sweeney and team suggests that past tax cuts have not corresponded to major economic growth in America.
That note points to two major examples of tax cuts that didn’t boost the economy.
Tax cuts under the Ronald Reagan and George W. Bush administrations came amid weak periods of business investment but failed to sustain economic growth. The Reagan tax cuts are what people refer to when they talk about the failure of “trickle-down economics.” And on the flip side, tax hikes in the early ’90s were followed by periods of sustained growth.
Another example is more recent, and more local. In 2012, Kansas tried to boost investment and employment by getting rid of income taxes for so-called pass-through businesses. These businesses include sole proprietorships, partnerships, and S corporations but exclude C corporations (most major companies are C corporations, and these companies are taxed separately from their owners, unlike S corporations).
On top of ditching the income tax for certain businesses, Kansas also lowered the top individual income tax rate to 4.6% from 6.45%. By looking at growth in nearby states, the Credit Suisse team figured out that the tax cuts did not in fact lead to economic growth in the state.
“What’s worse, these tax cuts have likely contributed to a worsening fiscal situation in Kansas with plunging revenues and debt downgrades,” Credit Suisse wrote.
Prior to Kansas’s tax reductions, economist & director of state projects at the Tax Foundation, Scott Drenkard, warned the Kansas House Committee that the tax cuts would result in either a decrease in spending or increased taxes elsewhere. The bill still passed.
When the tax cuts passed, the state estimated that 191,000 business owners would benefit. By 2013, however, the Wichita Eagle reported, the number had spiked to 280,737. Elaborating on this phenomenon, Drenkard wrote on the Tax Foundation website, “While decreasing taxes is generally associated with greater economic growth, the pass-through carve out is primarily incentivizing tax avoidance, not job creation.”
The Credit Suisse report analyzed these past tax cuts against the backdrop of proposals from Donald Trump and House Speaker Paul Ryan to cut business taxes.
Under Trump’s plan, pass-through businesses wouldn’t be taxed above 15%; Ryan wouldn’t tax them above 25%. Even Ryan’s more modest proposal would “create eye-popping deductions” for certain businesses, the Credit Suisse economists note.
While Ryan’s plan might create some hiring and investment among S corporations, Credit Suisse argues that the prospects for both seem limited. For one thing, pass-through businesses are more labor-intensive than capital-intensive, so they’re not likely to spend tax savings on investment.
Moreover, with a relatively low unemployment rate, pass-through businesses might be reluctant to bring on more workers. As Credit Suisse concluded: “Ultimately, business owners who find it difficult to expand may be especially likely to simply pocket their tax windfall.”
More from Omil: