Investors were finally treated yesterday to some of the most important compromise provisions to come out of the House-Senate conference on the Tax Cuts and Jobs Act. Among them were:

  • 21% corporate rate
  • Reduction of the top wage rate to 37%
  • 20% deduction on pass-through income
  • Full corporate expensing of capital investments for the next five years
  • Repealed corporate AMT
  • Mandatory one-time tax on corporate cash held overseas (taxed at 15%) and foreign-domiciled PP&E purchased with foreign earnings taxed at 10%
  • $10K deduction on individual state, local, and property taxes
  • Mortgage interest deduction on the first $750K of a mortgage
  • Doubling of the estate tax exemption
  • Lower individual rates are temporary and will be phased out over time

Net, net, this tax reform bill could a few very notable things from a macroeconomic and balance of payments perspective if economic agents obey the incentives. First, on the margin it incentivizes capital investment in the United States by, at least temporarily, raising the return on invested capital for owners of said capital. Second, it will add about $1tn of debt to the nation’s balance sheet over the next ten years after taking into consideration the boost to growth the bill could generate.

When considering the possible effects of changes to the tax code and budget deficits it’s useful to recall some fundamental identities of national income accounting. First, an individual’s income (i) can only be allocated in any of three ways: consumption ©, savings (S) or taxes (T).

This income is generated from the domestic sale consumption goods ©, investment goods (I), government services (G) or net exports (X-M).

Therefore, C+S+T=C+I+G+(X-M). We can further simplify the identity to T-G=(I-S) + (X-M).