With tax cuts in place, it is a lot easier to forecast the 2018 economy. Very simply, the economy is already growing solidly and the pace of activity should improve going forward. We could post the strongest growth in more than a decade.
The economy expanded at a 3 percent pace during most of 2017. Momentum was building at year’s end, and the tax cuts will boost growth further this year. A 3 percent expansion is not out of the question.
The tax cuts and better economic environment will clearly benefit executives and owners of capital. How much better workers do will be determined by how businesses distribute their windfall tax breaks.
As is usually the case, no good deed goes unpunished. In 2018, corporate profits will show a one-year surge largely due to the tax cuts.
And that creates the key issue for most firms. What do they do with their artificially higher, tax-cuts-created earnings so they can show profit growth in the future?
Firms may need to find ways to hide a lot of those profits, because the higher the profit base, the more they’ll need to earn to show good growth. Investors worry about increases, not necessarily levels.
Unfortunately, when we start talking financial engineering, you can be sure that not all those actions will benefit workers or even expand economic activity.
One way to hide profits is through bonuses. They make workers feel good, make for good public relations, and raise the cost of doing business — temporarily. If they go away in 2019, the reduction in bonuses turns into an increase in profits. Workers who normally don’t get bonuses but who receive them this year shouldn’t expect bonuses to be annual events.
Indeed, some companies have already announced that they are giving workers bonuses. But most of those doing so are extremely large firms that make up a relatively small proportion of all employment. The impact on total income and spending is likely to be minor.
In contrast, few companies, no matter what their size, are likely to be tempted to raise wages. To do so would lock the firm into a higher wage structure that will have to be funded going forward, and there is no certainty about how long the expansion will last.
Most firms will probably look for ways other than bonuses or wage increases to use the surge in profits.
Undoubtedly, merger and acquisition activity will increase. That is rarely good news for workers, as the acquiring firm typically cuts costs by reducing the workforce.
Companies may invest in capital, but that doesn’t necessarily bode well for workers. The tax incentive to invest is viewed as a way to get firms to become more productive. To do that, companies will be looking for ways to reduce, not increase, their workforces by employing capital rather than labor.
That is especially true in this labor-shortage environment. If growth is as strong as expected, we could approach the 50-year low unemployment rate of 3.4 percent last seen in May 1969.
With few workers available, you can bet that capital spending will be directed toward reducing the need for workers. The need to invest in labor-saving technology would be heightened if firms have to raise wages significantly to attract new workers.
In larger, publicly traded companies, some of the profits will go to boosting stock prices, by raising dividends and buying back stock. That would help investors and executives. However, it would also accelerate the redistribution of income toward upper-income households without necessarily improving business productivity or the spending power of lower- or middle-income households.
Since stock-price manipulation doesn’t add to production or spending, it would restrain the acceleration in economic growth deriving from the tax cuts.
As for small-business owners, they will see their taxes cut, but on average, not enough to hire many, if any, workers. Midsize firms may be able to invest more, but only if they are in growth industries. A firm should invest only if the new capital yields greater earnings over time. Tax cuts create sugar-highs, and once the growth surge ends, companies will have to determine whether their higher earnings level is sustainable.
And, finally, the accelerating economic activity, tightening labor markets, and possibly faster wage gains are likely to prod the Federal Reserve to hike interest rates. The faster the growth, the higher the rate hikes. And rising rates could sow the seeds for the next recession.
The economy should do extremely well this year. But for workers, the gains may be limited and short-lived.