INSIGHT: Analyzing the Macroeconomic Impacts of the Tax Cuts and Jobs Act on the States

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By Robert Carroll and Brandon Pizzola

While much has been written about the effects of the Tax Cuts and Jobs Act (Public Law 115-97) (TCJA) on the overall U.S. economy, less ink has been spilled over how the TCJA is expected to affect the economies of each of the 50 U.S. states (plus the District of Columbia). Interestingly, our analysis finds that in each of the next 10 years, the TCJA is estimated to increase the size of the overall U.S. economy and the economies of all states. Beyond 10 years, the TCJA’s impact on the U.S. economy is estimated to remain positive but be much more moderate, with greater variation across the states. (All estimates used are relative to the Congressional Budget Office’s projected baseline prior to enactment of the TCJA.)

Key Findings

  • National impacts. The TCJA is estimated to increase the size of the U.S. economy, as measured by gross domestic product (GDP)—by 1.2 percent over the first five years, 0.8 percent over the second five years, and 0.2 percent in the long run. (The JCT estimated that the TCJA will increase the level of U.S. GDP, on average, by 0.7 percent over 10 years, a smaller impact than estimated by this analysis. The JCT analysis does not present long-run impacts. See Joint Committee on Taxation, “Macroeconomic Analysis of The Conference Agreement For H.R. 1, The ‘Tax Cuts And Jobs Act’,” JCX-69-17, Dec. 22, 2018, p. 5.)
  • State impacts. The TCJA is expected to increase the size of all of the states’ economies over the next 10 years, with more variable impacts in the long run.
  • First five years (2018-22). The GDP increases range from 0.6 percent to 1.6 percent across all states, with the economies of the top 10 states estimated to increase by 1.4 percent on average and the bottom 10 estimated to increase by 0.9 percent.
  • Second five years (2023-27). The GDP increases range from 0.5 percent to 1.0 percent across the states, with the economies of the top 10 states estimated to increase by 0.9 percent on average and the bottom 10 states estimated to increase by 0.6 percent on average.
  • Long run (after all phase-ins and phase-outs). The GDP changes range from -0.2 percent to 0.5 percent, with the economies of the top 10 states estimated to increase by 0.3 percent on average and the bottom 10 states estimated to increase by 0.1 percent on average.

The state impacts vary due to differences in the composition of state economies, the sunset of some tax-reducing provisions and the delay of some tax-increasing provisions. (The major base-reducing provisions include 100 percent expensing and the deduction for qualified pass-through income. The major base-increasing provisions include the limitation on the deductibility of net interest expense and the required amortization of research and experimentation expenditures.)

Key Features of the TCJA Impacting the Economy

The TCJA has significant implications for the U.S. economy, affecting the decisions of both households and businesses through changes in the after-tax return to investment and after-tax reward to work. The following provisions are responsible for most of the changes in after-tax returns to investment:

  • Lower corporate income tax (CIT) rate (reduced from 35 percent to 21 percent)
  • Lower tax on pass-through income achieved through the combined effects of a reduced individual income tax and a 20 percent deduction for qualified business income
  • 100 percent write-off of qualified investment property (100 percent bonus depreciation)
  • Limits on interest expense deductibility
  • Requirement to amortize research and experimentation (R&E) expenditures

Several of these provisions, however, are temporary or delayed, leading to different effects in the near- and long-term. For example, the expensing provision phases out at the end of 2026 (80 percent in 2023, 60 percent in 2024, 40 percent in 2025, 20 percent in 2026, and 0 percent thereafter), and the deduction for qualified pass-through income sunsets at the end of 2025. As a result, there is a large near-term increase in the after-tax return to investment that is estimated to accelerate investment to the first half of the 10-year budget window. But in the long run these provisions have no impact on the accumulation of capital goods or on the level or growth rate of GDP. Similarly, the lower individual income tax rates (including the rate reduction from the pass-through deduction) increase the after-tax return to work, but only until their sunset at the end of 2025.

The law’s delay of a more stringent limitation on the deductibility of interest expenses and the requirement that R&E expenses be capitalized and amortized beginning in 2020, when considered separately from the TCJA’s other changes, reduce the after-tax return to investment in the longer term. (The limitation on the deductibility of net interest expense switches from a less stringent definition of adjusted taxable income consisting of earnings before interest, taxes, depreciation, and amortization (EBITDA) to the more stringent earnings before interest and taxes (EBIT) definition in 2022.) When these two permanent provisions are considered together, their effects offset much of the economic benefit from the lower corporate income tax rate, which is the primary permanent feature of the TCJA that contributes to a higher long-term level of investment and GDP.

Impact of the TCJA on Sate Economies: First Five Years (2018-22)

Figure 1 displays the impacts of the TCJA on the U.S. economy and state economies for the first five years of the 10-year budget window. The TCJA is estimated to increase the size of the U.S. economy—as measured by gross domestic product (GDP)—by, on average, 1.2 percent on average over the first five years, as shown in Figure 1. State GDPs are estimated to increase from 0.6 percent to 1.6 percent. The impacts vary by state due to differences in the composition of state economies.

Top 10 States by GDP Increase

The 10 states with the largest estimated GDP increases from the TCJA over the first five years (shown in teal in Figure 1) are estimated to have a 1.4 percent average increase in GDP. These states are: (1) Oregon (1.6 percent), (2) Michigan (1.5 percent), (3) Indiana (1.4 percent), (4) Texas (1.4 percent), (5) Wyoming (1.4 percent), (6) Ohio (1.3 percent), (7) Kentucky (1.3 percent), (8) North Dakota (1.3 percent), (9) Minnesota (1.3 percent), and (10) Illinois (1.3 percent).

While there are a variety of factors at work, many of these states have significant capital-intensive economic activity that benefits from—among other provisions—the 100 percent write-off of qualified property in each of these first five years. For example, in Oregon, which is estimated to have the largest percent increase of any state over the first five years (1.6 percent), approximately one-fifth of private industry (as measured by GDP) is durable manufacturing, more than three-quarters of which is attributable to computer and electronic product manufacturing. Overall, however, five of the top 10 states are within approximately 0.1 percentage points of the economy-wide average GDP increase of 1.2 percent.

Bottom 10 States by GDP Increase

The 10 states with the smallest estimated GDP increases from the TCJA over the first five years (shown in yellow in Figure 1) are estimated to have a 0.9 percent average increase in GDP. These states are: (1) Hawaii (0.6 percent), (2) District of Columbia (0.8 percent), (3) Maryland (0.9 percent), (4) Maine (0.9 percent), (5) Montana (0.9 percent), (6) Vermont (0.9 percent), (7) Nevada (1.0 percent), (8) Rhode Island (1.0 percent), (9) Virginia (1.0 percent), and (10) New Mexico (1.0 percent).

Whereas the states estimated to have the largest increases in GDP over the first five years generally have more capital-intensive economies, the states with the smallest estimated increases are generally more labor-intensive. In Hawaii, for example, only approximately 2 percent of the state’s GDP is attributable to manufacturing or mining. Similar to the top 10 states, four of the bottom 10 states are within approximately 0.2 percentage points of the economy-wide average GDP increase of 1.2 percent.

Impact of the TCJA: Second Five Years (2023-27)

Figure 2 displays the GDP effects on the U.S. and state economies for the second five years. The TCJA is estimated to increase the size of the U.S. economy—as measured by GDP—by 0.8 percent on average over the second five years. State GDPs are estimates to increase by between 0.5 percent and 1.0 percent. The effects are smaller than in the first five years because many of the TCJA’s major tax-reducing provisions sunset, while at the same time other tax-increasing provisions come into effect.

Top 10 states by GDP increase

The 10 states estimated to have the largest GDP increases from the TCJA over the second five years (shown in teal in Figure 2) are estimated to have a 0.9 percent average increase in GDP. These states are: (1) Delaware (1.0 percent), (2) Michigan (1.0 percent), (3) Oregon (0.9 percent), (4) Ohio (0.9 percent), (5) Texas (0.9 percent), (6) Indiana (0.9 percent), (7) Kentucky (0.9 percent), (8) Iowa (0.9 percent), (9) North Dakota (0.9 percent), and (10) South Dakota (0.9 percent).

The composition of the top 10 states is similar to that of the first five years because of the TCJA’s significant benefits to capital-intensive economic activity, even in the second five years. However, three states within the top 10 group do change: Delaware, Iowa, and South Dakota move in, while Illinois, Minnesota, and Wyoming move out. Illinois and Wyoming remain in the top 15. This change in the composition is due to several TCJA provisions that sunset or are delayed, which, when combined with the differences in the makeup of state economies, results in different state impacts. Notably, eight of the top 10 states are within approximately 0.1 percentage point of the economy-wide average GDP increase of 0.8 percent.

The GDP of Oregon, for example, is estimated to increase 1.6 percent over the first five years, but only 0.9 percent over the second five years. One factor contributing to the lower increase in the second five years is that computer and electronic product manufacturing—which comprises more than 15 percent of Oregon’s private industry—receives significantly less generous tax treatment because of the phase out of 100 percent expensing and requirement that R&E expenditures be amortized, among other provisions.

Delaware, notably, is an outlier among the top 10 states. Delaware’s growth is driven by the finance and insurance industry, which benefits from the lower corporate tax rate but is less affected by the phase-out of 100 percent expensing, more stringent interest expense limitation, amortization of R&E expenses, and sunset of most of the individual income tax provisions.

Bottom 10 States by GDP Increase

The 10 states with the smallest TCJA-driven GDP increases over the second five years (shown in yellow in Figure 2) are estimated to have a 0.6 percent average increase in GDP. These states are: (1) Hawaii (0.5 percent), (2) District of Columbia (0.5 percent), (3) Maryland (0.6 percent), (4) New Mexico (0.7 percent), (5) Vermont (0.7 percent), (6) Maine (0.7 percent), (7) Virginia (0.7 percent), (8) New Jersey (0.7 percent), (9) Montana (0.7 percent), and (10) Nevada (0.7 percent). The composition of the bottom 10 states is largely unchanged between the first five years and second five years. The only change is that New Jersey is now included in the bottom 10 states (moved from 39 to 44) and Rhode Island is excluded (moved from 44 to 39). Similar to the top 10 states, seven of the bottom 10 states are within approximately 0.1 percentage point of the economy-wide average GDP increase of 0.8 percent.

Impact of the TCJA: Long run

Figure 3 displays the long run impacts of the TCJA on U.S. and state GDP. The TCJA is estimated to increase the size of the U.S. economy—as measured by GDP—by 0.2 percent on average in the long run. This is a much smaller effect than over the 10-year budget window because major tax cuts sunset while other permanent tax increases phase in. The impact on state GDP ranges from -0.2 percent to 0.5 percent. The long-run results reflect the state-specific net impact of CIT rate reduction, the net interest expense deduction limitation, and the mandatory amortization of R&E expenditures, which are the major permanent provisions of the TCJA. States with above-average expansions, for example, tend to benefit disproportionately from the CIT rate reduction. Those with smaller expansions or even contractions tend to be hit harder by the net interest expense deduction limitation or the required amortization of R&E expenditures.

Top 10 States by GDP Increase

The 10 states with the largest GDP increases from the TCJA in the long run (shown in teal in Figure 3) are estimated to have a 0.3 percent average increase in GDP. These states are: (1) Delaware (0.5 percent), (2) New York (0.3 percent), (3) Michigan (0.3 percent), (4) South Dakota (0.3 percent), (5) Iowa (0.3 percent), (6) North Dakota (0.3 percent), (7) Kentucky (0.3 percent), (8) Connecticut (0.3 percent), (9) Georgia (0.3 percent), and (10) Nebraska (0.3 percent). The composition of the top 10 states is significantly different than the first or second five years. This is because many important provisions of the TCJA eventually sunset or are implemented later. As a result, the fully phased in TCJA has very different impacts than over the short and medium term.

Delaware, for example, is estimated to have the largest long-run GDP increase (0.5 percent, as compared to the national average of 0.2 percent). This is primarily due to a significant portion of Delaware’s GDP being attributable to the finance and insurance industry, which, as mentioned above, benefits from the CIT rate reduction but is not much affected by the net interest expense deduction limitation or by the mandatory amortization of R&E expenditures. Additionally, only a relatively small share of the state’s GDP is attributable to industries with significant base-broadening in the long run. Such industries include chemical products and computer and electronic products manufacturing. New York, which has the second largest increase in GDP in the long run (0.3 percent increase relative to the pre-TCJA baseline), has a similar result. Overall, however, nine of the top 10 states are within approximately 0.1 percentage point of the economy-wide average GDP increase of 0.2 percent.

Bottom 10 States by GDP Increase

The 10 states with the smallest long-run TCJA-driven GDP effects (shown in yellow in Figure 3) are estimated to have a 0.1 percent average increase in GDP. These states are: (1) Oregon (-0.2 percent), (2) California (0.1 percent), (3) Louisiana (0.1 percent), (4) North Carolina (0.1 percent), (5) West Virginia (0.1 percent), (6) Idaho (0.1 percent), (7) Indiana (0.1 percent), (8) Maryland (0.2 percent), (9) Vermont (0.2 percent), and (10) New Mexico (0.2 percent). The composition of the bottom 10 states is fairly different than in the first or second five years, because many provisions of the TCJA sunset while others phase in over time.

The only state with an estimated contraction in GDP in the long run is Oregon. While Oregon is estimated to have the largest GDP increase of any state in the first and second five years, Oregon’s GDP is estimated to contract 0.2 percent in the long run. The estimated GDP decrease for Oregon can be ascribed to the state’s research-intensive manufacturing. More than 15 percent of the state’s private industry is attributable to research-intensive computer and electronic products manufacturing, which is negatively affected by the net interest expense deduction limitation and the mandatory amortization of R&E expenditures. The other nine states in the bottom 10 are estimated to have GDP increases of 0.1 percent to 0.2 percent, similar to the national average of 0.2 percent.

Conclusion

While this analysis breaks down and explains some of the anticipated effects of the TJCA on the U.S. economy and each of the 50 states (plus the District of Columbia), businesses also need to understand—through more detailed financial and economic modeling—how tax reform will impact their company and industry. As such, businesses and industry groups should consider undertaking more detailed analyses that quantify the impacts for their specific company, subindustry, suppliers, competitors, and markets. In addition to examining their own specific situations, businesses should also assess the effect of tax reform on their customers, competitors, suppliers, and employees. These types of analyses can help businesses understand how the TCJA and other tax policy changes may affect future business plans and inform discussions with stakeholders and policymakers.

Appendix: About These Estimates

Ernst & Young LLP’s QUEST group estimated these impacts using the EY QUEST macroeconomic model of the U.S. economy. The EY QUEST macroeconomic model of the U.S. economy is similar to general equilibrium models used by the Congressional Budget Office, the Joint Committee on Taxation, and U.S. Treasury Department. (See, for example, Shinichi Nishiyama, “Fiscal Policy Effects in a Heterogeneous-Agent Overlapping-Generations Economy With an Aging Population,” Congressional Budget Office, Working Paper 2013-07, December 2013; Joint Committee on Taxation, “Macroeconomic Analysis of the ‘Tax Reform Act of 2014, “February 2014 (JCX-22-14); Joint Committee on Taxation, “Macroeconomic Analysis of Various Proposals to Provide $500 Billion in Tax Relief,” March 2005 (JCX-4-05); and, Treasury Department, “The President’s Advisory Panel on Federal Tax Reform, Simple, Fair, & Pro-Growth: Proposals to Fix America’s Tax System,” November 2005.) In this model, tax policy affects the incentives to work, save and invest, and to allocate capital and labor among competing uses. Representative individuals and firms incorporate the after-tax return from work and savings into their decisions of how much to produce, save and work.

The general equilibrium methodology accounts for changes in equilibrium prices in factor (i.e., capital and labor) and goods markets and simultaneously accounts for the behavioral responses of individuals and businesses to changes in taxation. Behavioral changes are estimated in the overlapping generations framework, whereby representative individuals incorporate changes in current and future prices when deciding how much to consume and save in each period of their life.

To generate state specific estimates, this analysis starts with national industry-specific results calculated using the QUEST macroeconomic model. It then allocates these to each of the 50 states plus the District of Columbia based on the industry composition of each state. The industry detail included in this model corresponds approximately with three-digit North American Industry Classification System (NAICS) codes. There were at least two noteworthy adjustments to this allocation. First, the allocation of the construction industry—because it is estimated to have significant growth as a result of overall increased investment throughout the U.S. economy—was based on each state’s estimated change in GDP excluding the construction industry. Second, state results were adjusted to account for the state-specific impacts of the TCJA’s limitation on the state and local tax deduction. Specifically, the change in each state’s average marginal tax rate on labor from the state and local tax deduction limitation was estimated, the responsiveness of GDP to a small change in the average marginal tax rate on labor was estimated in the national model and applied to each state, and all state results were then scaled to be consistent with the national impact of the TCJA on GDP.

An important caveat is that this analysis does not explicitly model the detail of the state tax systems. In particular, other than the adjustment for the state-specific impact of the state and local tax deduction limitation, it does not measure effects from the interaction between state and federal tax systems. Notably, the TCJA will likely lead to significant changes to state tax bases, and how states choose to respond to these changes could impact the results.

Robert Carroll is a principal and Brandon Pizzola is a senior manager in Ernst & Young LLP’s Quantitative Economics and Statistics group.

The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global Ernst & Young organization.

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