Recent academic research explores the unintended consequence of uncertainty regarding executive and legislative political actions on corporate outcomes. It specifically finds that tax policy uncertainty leading up to and during Donald Trump’s first presidential term negatively affected corporate investments. This study’s findings shed light on the potential adverse effects of the uncertainty of the current tax policy that companies are facing.
As many provisions from the Tax Cuts and Jobs Act of 2017 are on the cusp of sunsetting and the new presidential and congressional terms are now in full force, a cloud of tax policy uncertainty presides over taxpayers. According to a recent research study forthcoming in the Journal of Accounting Research, this type of uncertainty can affect a corporation’s investment activities.
Managers form expectations on how their company will perform, and they use these expectations to shape important company decisions like capital expenditures. However, many internal and external complexities cast uncertainty on corporate outlooks, and this uncertainty diminishes managerial ability to formulate and act on these expectations. This uncertainty might even lead managers to delay capital expenditures or pass on these investments altogether.
One particularly impactful type of uncertainty surrounds tax policy. For most corporations, income tax expenses are among the most material items on their income statement, and changes to tax laws can dramatically impact firms’ earnings. While current times have significant tax policy uncertainty, a time period with equivalent uncertainty was the period surrounding the 2016 Presidential election and the subsequent year when Trump’s signature tax package was proposed and passed into law. President Trump was elected to office with a platform for significantly altering the Internal Revenue Code. Furthermore, the bill was introduced into committee on Nov. 2, 2017 and passed into law on Dec. 22, 2017. This rapid window left little time for managers to comprehend and internalize the many tax policy nuances. These details left many managers with a diminished ability to form expectations and subsequently act on those expectations for important decisions like capital expenditures.
In a study titled, “Tax Policy Expectations and Investment” researchers examined a sample of 5,498 observations across 928 unique publicly traded corporations from 2014 to 2019. The corporations in the sample were large, with an average size of over $1.8 billion in total assets and over $210 million in average capital expenditures. The article is co-authored by John Gallemore of the University of North Carolina at Chapel Hill, Stephan Hollander of Tilburg University, Martin Jacob of IESE Business School, and Xiang Zheng of Nanyang Technological University.
“The world is increasingly partisan, and it is clear that political beliefs shape how people think about the world. While the traditional thinking about firms is that they are simple profit maximizers, in reality, they are run by people who may not have the same beliefs. Thus, we wanted to study how managers’ beliefs and expectations related to politics might shape firm behavior,” says Gallemore.
The researchers first show that tax policy uncertainty spiked after the 2016 election, consistent with it being a surprise election result that significantly impacted the potential for major tax reform. They then show that there is a lot of variation in corporate tax policy uncertainty, with some companies facing fairly low uncertainty and others experiencing fairly high uncertainty.
Perhaps most directly related to the research question, the researchers find that tax policy expectations are associated with firm investment. Gallemore states, “When firms are feeling more positive about tax policy, they invest more and are more responsive to tax incentives. Alternatively, when firms feel more uncertainty about tax policy, they reduce their investments and do not respond to tax changes. Thus, managers’ expectations over tax policy can affect their firms’ behavior, and thus overall economic growth.” The study specifically estimates that corporations that benefited from the Tax Cuts and Jobs Act of 2017 increased capital investment by about 10% of the average investment among companies in their sample. However, tax policy uncertainty significantly diminishes the increased investment. They also find significant variation in the results depending on whether the company is multinational or domestic.
Gallemore concludes, “From a policy perspective, our results suggest that certain policymaker habits have negative real effects on firm investments. For example, in the U.S., tax policy is often made using sunsetting provisions such as policies that expire after a certain amount of time, and thus needs to be renewed frequently. If there is uncertainty over whether tax policies will in fact be renewed, perhaps because there is a change in government, then this could depress firms’ investment responses to those policies. Furthermore, these expectations can also shift the location of firms’ investment, and thus could impact the extent to which firms onshore investment into the U.S.”
These findings help shed light on how corporations might be responding to the current era of tax policy uncertainty. While these results relate to a prior era, recent articles provide complimentary evidence, suggesting the findings likely generalize to the current era of tax uncertainty under Trump’s second term. For instance, according to an article in Bloomberg, companies are already having to consider the impacts of tariffs on their spending plans. Another academic study recently published in the Journal of the American Taxation Association suggests that tax policy uncertainty affects corporate tax decisions.
Gallemore, Hollander, Jacob, and Zheng’s findings in the Journal of Accounting Research illuminate the potential unintended consequences of tax policy uncertainty and how it might negatively impact company growth via capital expenditures. Trump’s tax policy in his second term has been characterized by a push for expansive changes to how the U.S. taxes corporations via implementing international tariffs on the import of goods from other countries (and the associated “reciprocal tariffs”) or by making material changes to the U.S. tax law (either via reinstatement of many policies from the Tax Cuts and Jobs Act of 2017 that are set to sunset in the coming years or adding new provisions to the Internal Revenue Code), this study helps companies and stakeholders to understand unintended burdens they might be facing until the tax policy uncertainty resolves.
Read the full article here
