Why Corporations are Prioritizing Shareholder Value over RD and Expansion with Trump Tax Cuts

Any honest politician with even a basic understanding of economics could have predicted the outcome of the 2017 tax legislation. However, it often appears that the true motives are not always clear to the general public. why? The incentives created by the tax cuts are driving corporations to prioritize increasing their share value over investing in research and development (RD) or expanding their production capabilities.

The Impact of Tax Cuts on Corporations

Before the 2017 tax legislation, the federal government provided up to a 35% subsidy of labor costs for ‘C’ corporations through immediate tax deductions. This effectively reduced the after-tax cost of labor by a significant 20%. The tax legislation has reduced this to a maximum of 21%, raising the after-tax cost of labor even further. Moreover, the new rules expanded the ability of corporations to immediately deduct the full cost of capital assets, even used ones.

The Shift to Automation

These incentives have led to a greater push for automation. Suddenly more expensive labor is being replaced with cheaper automation. These changes are being fueled by increased government debt, which drives up interest rates. Corporations now need to pay increased dividends to continue raising capital due to these higher interest rates.

The Motive Behind Stock Buybacks

Because the CEO's job is to make money for their stockholders, buying up the company's shares is an effective way to increase share value. Long-term investments in RD or expansion may be beneficial, but given the time constraints until the next stockholders' meeting, these are often not the top priority.

Reasons for Lack of Investment

There are several reasons why corporations are not investing in long-term growth, despite the potential benefits:

1. Historical Trends

The current global economic expansion has been running for about 10 years since the trough of the last recession. Historically, expansions of this duration are often followed by contractions, making increased investment seem less attractive.

2. Labor Market Dynamics

Unemployment is at near-record lows, making it difficult and expensive to hire effective workers. This trend suggests that labor costs are likely to rise in the future, affecting both current profit margins and the viability of new investments.

3. Consumer Demand and Income Levels

A significant portion of the mass market, particularly lower and middle-income consumers, have seen no increase in their disposable income for decades. Their borrowing is at record levels, and they are nearing their borrowing limit. They are unlikely to be able to increase their spending significantly.

4. Government Debt and Fiscal Policy

Following the tax cuts, the government is running a record deficit near $1 trillion, which is about 30% of its income. In the long term, fixing this deficit would require either large tax increases or significant cuts in expenditures, both of which will likely decrease demand.

Conclusion

Given these economic factors, corporations are likely anticipating a recession within the next two years. With this in mind, it would be imprudent to embark on significant capacity expansion at present. The focus on immediate returns through share buybacks ensures that current stockholders benefit, even if it means forgoing long-term benefits for the company and its employees.