The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Tax Effects by Industry

Summary

This brief reports Penn Wharton Budget Model’s (PWBM) estimate of effective federal corporate tax rates across the 19 main industrial sectors under current law and under the Tax Cuts and Jobs Act (TCJA), as reported out of conference committee on December 15, 2017. All sectors gain under TCJA but with considerable variation across industries and time. Moreover, more than half of effectiveness of the corporate tax cut is undone within 10 years.

Key Points

  • The current U.S. statutory corporate tax rate is 35 percent. However, due to various deductions, credits and income deferral strategies, most corporations pay a lower rate, known as the effective tax rate (ETR), which averages about 23 percent under current law across all industries over the next decade. However, this value varies considerably across industries, with mining paying 18 percent and agriculture paying 33 percent.

  • The TCJA reduces the statutory corporate tax rate from 35 to 21 and the average ETR falls from 21 to 9 percent in 2018. However, by 2027, the ETR doubles in value to 18 percent, mostly due to expiring provisions.

  • In the short run, the biggest winners of the TCJA are capital-intensive industries like utilities, real estate and transportation, which benefit the most from temporary expensing of equipment. However, over time, several industry ETR’s will actually rise above the new statutory rate of 21 percent in future years.


The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Tax Effects by Industry

Introduction

Penn Wharton Budget Model’s (PWBM) previously reported static and dynamic analysis of both the House and the Senate versions of the Tax Cuts and Jobs Act (TCJA). Because of differences in these bills, a House-Senate conference committee was created and recently produced a joint conference bill on December 15, 2017, which will be soon voted upon in both chambers.

While considerable recent attention has been paid to the macroeconomic and the distributional impact of potential tax cuts, less attention has been paid to how the impact of a tax cut might differ by industry. This brief presents PWBM’s calculations of effective corporate tax rates by industry under current law and TCJA’s projected impact.

Terminology

While the U.S. statutory tax rate currently stands at 35 percent for C corporations, very few companies actually pay that amount. The use of various deductions, credits and income deferral strategies allow companies to pay a lower rate. This lower rate is known commonly as the effective tax rate (ETR), which is calculated by dividing taxes paid by book income. Book income is pre-tax financial income reported on company income statements.

Methodology

This brief presents PWBM’s calculations of federal ETR’s by industry under current law as well as TCJA’s projected impact. PWBM’s methodology for calculating the average effective federal corporate rate parallels the methodology used by the Office of Tax Analysis at the Department of Treasury.1 Our corporate tax model uses publicly available data from the National Income and Product Accounts (NIPA) and Statistics of Income (SOI) to project book income and taxes paid. The determinants of tax paid (income, deductions and credits) are projected at the industry level for two-digit North American Industry Classification System (NAICS) industries.

Validation

PWBM routinely uses historical data to validate its methodology. Figure 1 plots the corporate tax model’s estimates of average effective tax rates by industry against actual data for 2013, which is the latest year of available data. The figure displays, from left to right, the least-accurately predicted industry ETR to the most-accurately predicted. The diamond-shaped points that are also shown in Figure 1 indicate the amount of book income (measured against the right-hand side axis) in each industry. Not surprisingly, the model more accurately predicts ETRs in 2013 for industries that have larger amounts of book income. Because larger industries produce more total book income and pay more taxes, small prediction errors in either component have less effect on the ratio of the two. Overall, the model produces a good match with historical data across most of the industries, and it does particularly well in aggregate (“All Industries”). However, estimates for some smaller industries, when the gaps between predicted and actual taxes paid in 2013 are larger, should be interpreted with more caution. For these industries, a greater variance in income and taxes over time, combined with the small number of tax returns, result in more prediction variance.2

Figure 1: Effective Corporate Tax Rates, 2013

Figure_1.png

Major TCJA Provisions Impacting ETR

The TCJA contains several provisions, including some phase-outs of those provisions, over the next decade that impact the calculation of ETR by industry. A partial list includes:

2018: Corporate rate drop to 21 percent; Increased 179 (equipment and software) Expensing; Extension and Expansion of Bonus Depreciation; Limitation of Net Interest Deductions; Limitation of Net Operating Loss Deduction; Repeal of Domestic Production Activities Deduction

2022: Amortization of Research and Experimental Expenditures; change in rules for Limitation of Net Interest Deductions

2023: Start of phase-out of Extension and Expansion of Bonus Depreciation

2026: Complete phase-out of Extension and Expansion of Bonus Depreciation

Effective Tax Rates by Industry

Table 1 shows PWBM’s estimated ETRs for the nineteen NAICS industries under current law and under the TCJA in four years: 2018, 2023, 2027 and 2040. Year-by-year values are available as an Excel download.

The ETR, averaged across all industries (weighted by size of industry), declines from 21.2 percent to 9.2 percent in 2018. In 2023, after changes to various deductions under TCJA go into effect, the decline in rates is smaller, from 23.5 percent to 17.3 percent. By 2027, the drop is even smaller, from 22.9 percent to just 18.9 percent.

At first glance, the higher effective rates in 2023 and 2027 seem counterintuitive. However, they reflect the fact that a portion of depreciation deductions can no longer be taken since the investments were fully expensed in prior years. Specifically, under current law, many capital investments would have been depreciated gradually over the next decade. Under TCJA, that depreciation is accelerated, producing lower ETR’s immediately after TCJA is enacted but at a cost of eliminating depreciation allowances later on. Of course, companies are better off in present value terms, since an immediate tax reduction is more valuable than a future reduction. However, much of the short-run reduction in ETR values simply reflects a shift in timing of depreciation allowances rather than an average reduction in the long run.

Table 1: Effective corporate tax rates by industry

Industry Scenario 2018 2023 2027 2040
All industries Current law 21.18% 23.53% 22.95% 21.93%
TCJA 9.16% 17.33% 18.88% 16.06%
Accommodation and food services Current law 15.13% 16.29% 15.41% 13.60%
TCJA 8.46% 10.60% 10.42% 7.83%
Administrative and support and waste management and remediation services Current law 25.68% 28.50% 27.75% 26.46%
TCJA 13.90% 19.82% 20.30% 16.34%
Agriculture, forestry, fishing, and hunting Current law 30.06% 33.27% 32.71% 32.01%
TCJA 16.72% 24.46% 25.36% 22.47%
Arts, entertainment, and recreation Current law 26.61% 30.09% 29.10% 27.37%
TCJA 15.37% 23.04% 23.99% 20.40%
Construction Current law 28.50% 31.76% 31.16% 30.30%
TCJA 16.01% 23.58% 24.32% 21.21%
Educational services Current law 28.95% 31.95% 31.34% 30.46%
TCJA 16.42% 23.58% 24.34% 21.30%
Finance and insurance Current law 26.08% 28.90% 28.52% 27.88%
TCJA 14.30% 20.82% 20.71% 18.61%
Health care and social assistance Current law 29.42% 32.40% 31.57% 29.54%
TCJA 16.59% 24.04% 24.76% 21.10%
Information Current law 22.40% 25.23% 24.63% 23.63%
TCJA 12.76% 19.34% 19.91% 16.46%
Management of companies (holding companies) Current law 16.17% 17.18% 16.82% 15.92%
TCJA 8.73% 10.19% 9.10% 8.93%
Manufacturing Current law 17.51% 19.36% 18.77% 17.68%
TCJA 10.94% 15.92% 16.26% 14.02%
Mining Current law 15.83% 18.66% 17.56% 16.01%
TCJA 7.37% 11.87% 14.64% 2.88%
Other services Current law 29.41% 32.55% 31.96% 31.15%
TCJA 16.32% 23.84% 24.65% 21.51%
Professional, scientific, and technical services Current law 25.41% 28.82% 28.11% 26.83%
TCJA 14.29% 22.10% 22.62% 19.69%
Real estate and rental and leasing Current law 26.50% 30.22% 29.30% 27.99%
TCJA 10.85% 22.96% 24.17% 20.50%
Retail trade Current law 27.49% 30.28% 29.68% 28.82%
TCJA 15.58% 22.18% 22.96% 20.25%
Transportation and warehousing Current law 28.78% 31.86% 31.27% 30.52%
TCJA 15.97% 23.23% 24.22% 21.31%
Utilities Current law 28.83% 32.17% 31.22% 29.72%
TCJA 15.62% 23.43% 24.64% 21.42%
Wholesale trade Current law 25.90% 28.68% 28.09% 27.21%
TCJA 14.45% 20.60% 21.31% 18.41%

Table 1 shows that capital intensive industries like Utilities, Real Estate, Transportation, Agriculture and Health Services3 benefit most from full expensing. These industries see at least a 12.8 percentage point drop in effective rate, but by 2027 these industries give back most of the ETR drop realized in 2018. In fact, these industries see effective rates rise above the statutory rate for two main reasons. First, for capital investments that were fully expensed, no future depreciation is allowed, but future book income is still net of economic depreciation in future years. Second, the limitation on net interest deductions increases taxes even though book income is net of interest payments. In fact, some industries that are relatively heavily debt financed, including agriculture, see their ETR’s increase above the statutory rate even before expensing begins phasing out.

Notice that Manufacturing and Mining see smaller drops in ETR than the average across industries. These industries already have low ETRs because of preferential treatment under current law and so their rates cannot fall much further. The benefit these industries see from a drop in the statutory rate is restricted by both the limitation of net interest deduction beginning in 2018 and the change in the treatment of research and experimentation expenses beginning in 2022. Manufacturing, in particular, accounts for almost two-thirds of research costs, which are fully deductible under current law. Under TCJA, those costs must be capitalized over a period of five years, sharply reducing the tax benefit received by manufacturers.

ETR’s across industries fall between the years (approximately) 2027 and 2040, the last year shown in Table 1. As expensing phases out, it is replaced with depreciation more similar to current law. That depreciation is then applied to new investment made after the beginning of the phase out of the full expensing provision, thereby reversing some of the time shifting in ETR’s noted above. ETR’s are still lower relative to current law due to other TCJA provisions. However, by 2040, the ETR across all industries is 16 percent, just a bit lower than the 22 percent under current law.

Measured as Total Taxes Paid

Table 2 shows the change in taxes paid by industry in dollar terms over the 10-year budget window. Despite facing relatively small declines in ETR’s relative to other industries, the largest winner is Manufacturing with $261.5 billion in tax savings, equal to about 20.5 percent of the total reduction in all U.S. C corporate taxes paid.

Finance and Insurance also sees significant gains of $249.4 billion, or about 19.5 percent of the total reduction in all C corporate taxes paid, despite paying only 17.8 percent of corporate taxes under current law. The drop in statutory rate benefits every industry and is the largest factor in each industry’s effective rate drop. However, the net operating loss and interest deduction limitations disadvantage industries that have a large stock of losses or are heavily debt-financed. Furthermore, TCJA shifts the timing of depreciation deductions, which results in some industries paying more in taxes over the 10-year window.

In fact, despite facing a lower ETR relative to current law, the Utilities and Arts, Entertainment and Recreation4 industries are expected to pay more in taxes over the next decade, although they still benefit over a longer time period. The reason is that our model captures several key factors that impact the amount of book income, including income reclassification and income shifting. These particular industries will realize more book income, thereby generating a larger tax bill, despite lower rates.

Table 2: Taxes paid by industry (Billions of Dollars)

2018-2027
Industry Current Law TCJA Tax Saving
Agriculture, forestry, fishing, and hunting 22.3 14.5 7.8
Mining 63.4 25.4 38.0
Utilities 82.6 98.2 -15.6
Construction 39.7 26.8 12.9
Manufacturing 1,204.7 943.2 261.5
Wholesale trade 365.0 218.5 146.5
Retail trade 442.5 271.1 171.4
Transportation and warehousing 145.2 82.5 62.7
Information 322.0 222.8 99.2
Finance and insurance 715.6 466.2 249.4
Real estate and rental and leasing 42.3 29.6 12.7
Professional, scientific, and technical services 130.0 107.3 22.7
Management of companies (holding companies) 321.1 166.9 154.2
Administrative and support and waste management and remediation services 40.5 21.5 19.0
Educational services 9.0 5.3 3.7
Health care and social assistance 28.3 22.4 5.9
Arts, entertainment, and recreation 5.0 5.5 -0.5
Accommodation and food services 39.5 21.5 18.0
Other services 10.5 5.9 4.6
Total (All Industries) 4,029.2 2,755.1 1,274.1

Conclusion

The TCJA reduces effective tax rates across all industries but has a differential impact by industry. Moreover, much of the impact is temporary. While TCJA reduces the effective tax rate in 2018 to just 43 percent of its value under current law, the effective tax by 2027 is 80 percent of its current-law value.


  1. The Office of Tax Analysis includes federal, state, local and foreign corporate taxes in its measure of effective tax rates. PWBM’s measure includes federal corporate taxes only.  ↩

  2. The U.S. Treasury analysis referenced earlier reduces prediction variance by excluding or combining several small industries. However, we felt it was more informative to provide the full industry-level decomposition, even with higher prediction errors for some smaller industries.  ↩

  3. Some of these industries are more capital intensive than commonly understood due to the breadth in definition under the two-digit North American Industry Classification System (NAICS). See the link provided earlier. For example, Health Care includes capital-intensive health care facilities and Real Estate includes rental and leasing, as already indicated in Table 1. Moreover, as noted above, the analysis herein focuses on C corporations. A significant share of some industries, including, Real Estate, are currently organized as pass-through companies that receive separate tax considerations under TCJA that are not analyzed herein. However, pass-throughs can always do as well as C corporations by "checking the box" and being taxed as C corporations.  ↩

  4. Arts, Entertainment and Recreation include corporations that own structures like arena, racetracks, casinos and marinas each of which is likely debt-financed.  ↩