Corporate tax cuts will put billions of dollars back in the hands of businesses this year. Naturally, people want to know how those businesses will spend it. But the answer doesn’t really matter, at least not for understanding whether the tax cuts were a good idea.
That’s because the economic case for corporate tax cuts has almost nothing to do with what corporations do with the extra cash.
Economists generally recognize that corporate tax cuts have two quite distinct effects.
First, a tax cut increases the incentive to invest. A lower corporate tax rate gives investors in a new factory a larger share of the income that factory generates. And that in turn leads more investment projects to pass the cost-benefit test that tells a company whether it’s worth building the factory in the first place.
This incentive effect drives most economic models of investment, and few economists debate its underlying logic, although there’s considerable debate as to whether it will yield a large or small increase.
Second, a tax cut showers extra cash on companies. That cash largely comes from companies that are suddenly paying a lower tax rate on profits earned from past investments. This windfall has a big effect on the distribution of income, with billions of dollars going to owners of capital at the expense of taxpayers. But few economists believe that this cash transfusion will do much to bolster future investment, because the profitability of a new capital project depends on future revenues and expenses, not on how much cash a company has lying around.
