Taxes and the macro economy

Abstract

My research with Furman (2018) assessed the 2017 U.S. tax reform and concluded that economic growth would be boosted by about 1 percent per year for 2018-19 and to a lesser extent for the following eight years. This forecast accorded well with realizations through the first quarter of 2019, but subsequent growth is slower, likely due to adverse effects from the ongoing trade war. Extensions from the previous research consider effects from businesses’ choices of legal form between corporate and pass-through status. Corporate form conveys benefits from perpetual legal identity, limited liability, potential for public trading of shares, and ability to retain earnings. However, legal changes have enhanced pass-through alternatives, for example, through the invention of the S-corporation in 1958 and the improved legal status of LLCs (limited liability companies) at the end of the 1980s. Corporate form is subject to a time varying tax wedge, which offsets the productivity benefits. In a theoretical framework, with a distribution of firms’ productivities associated with corporate and pass-through status, the tax wedge determines the fraction of firms that opt for corporate status, the level of economy-wide output (productivity), and the share of output generated by corporations. This framework underlies the empirical analysis of corporate shares of business economic activity. Long-difference regressions for 1968-2013 show that a higher tax wedge reduces the corporate share of gross assets. The corporate share also exhibits downward trends, likely reflecting underlying legal changes.