Update October 5, 2017:
On September 27, President Trump announced his latest proposed tax reforms. As with previous versions, the plan's key components include lowering both personal and corporate tax rates and simplifying the tax code by reducing the number of personal income tax brackets from seven to three and by eliminating many itemized deductions. The President and his staff continue to assert that these changes will spur economic growth to at least 3 percent annually. Certain important details do still remain unspecified, such as the income levels to which each proposed tax bracket would apply. However, even without these details, there is enough clarity about the current proposed framework to confirm that our conclusions below regarding the impact of the plan on new-car sales still hold.
President Trump campaigned on a platform that prominently featured significant tax cuts to individuals and businesses to stimulate economic growth. He recently announced a plan with the promised changes that he purports will increase economic growth to 3 percent. At first glance, it is unclear that these tax cuts will drive much new-car sales growth. The proposed cuts will most benefit the car buyers who least need them — the wealthy — and not the groups who are underrepresented among new-car purchasers and more likely to spend the extra money on both non-durables and durables, including autos. But, should the plan succeed in motivating enough consumer spending and business investment to reach its economic growth goal, we anticipate that the resulting job creation will in fact spur new-car sales growth of 0.6 percent to 2.25 percent and even more once multiplier effects are accounted for. The key question is whether 3 percent economic growth is actually attainable.
What It Is:
President Trump recently proposed a plan to overhaul the tax code. The highlights of his plan included simplifying the current seven-bracket system applied to ordinary income to three reduced rates; doubling the standard deduction; eliminating the alternative minimum tax and the estate tax; decreasing the capital-gains tax; and lowering corporate taxes from 35 percent to 15 percent. Not all details, including where the new brackets will start and end, have been released, but in earlier versions of Trump's plan, personal tax cuts were the most substantial for the most affluent. For example, by one estimate:
Impact: Minimal Sales Increase Most Likely
1) Personal Tax Cuts
Economists are divided and the evidence is mixed on what impact tax cuts have on consumer spending, and ultimately, economic growth. Some studies have found that the impact depends on who gets the tax cuts. That is, higher-income people are more likely to save the extra income from tax cuts or use it to pay off debt since they can typically use existing savings or borrow to support additional spending, such as buying a new car, at any time. This finding suggests that a tax cut is unlikely to cause higher-income consumers — the key beneficiaries of Trump's proposed plan — to buy new cars that they wouldn't have bought anyway. On the other hand, research finds that moderate- to lower-income people are more likely to spend the extra income from tax cuts, and that as the amount of the tax cut increases, spending on durable goods, namely autos, becomes more likely.
Under the potential changes outlined above, it is unlikely that the low amounts offered to individuals making $48,400 or less would be a motivating factor in a new-car purchase. Similarly, individuals making over $150,000 are unlikely to change their new-car purchase rates due to the increase in income. However, for individuals earning median income and the next quartile above (roughly $48,400 to $125,000), savings of roughly $1,000 to $2,000 annually could contribute meaningfully to a down payment on a new car or to monthly payments. To estimate the additional purchases that would be made by this group, we start by calculating the annual shares of people in each income group who purchase a new car currently, shown in the chart below. Assuming each group's buying after tax cuts shifts to the next higher income group's purchase rate, we would expect new-car sales to increase by 0.8 percent. Note that this is a generous assumption since, for the majority of households, the tax savings will likely not increase their income enough to move them to the next income bracket.
Sources: Edmunds.com, Polk, U.S. Census Bureau
2) Economic Growth
Personal spending of the extra income from Trump's proposed tax cuts on new cars is one way that new-car sales could grow due to this policy. Higher sales could also result from the impact of tax cuts on economic growth, which could generate additional jobs. Trump claims that his plan will increase economic growth to 3 percent, versus the 2 percent that is currently predicted by the Federal Reserve for the next two years or more. Two sources of potential growth from the tax cuts include: 1) additional consumption and 2) hiring or investment from firms. Based on the relationship of gross domestic product (GDP) and employment, we estimate that a 1 percentage point increase in GDP will result in a 0.6 percentage point increase in employment, or approximately 900,000 new jobs based on the current labor force with 151 million employed.
Based on Edmunds' analysis, new-car sales could increase at a rate ranging from 0.6 percent to 2.25 percent in the first year of the program alone, just based on higher retail purchases. These estimates assume that jobs would be in a variety of industries at salaries ranging around the mean U.S. annual salary ($49,630 is the average, and the assumed range is $40,000 to $74,999). For the low endpoint of expected growth, new-car purchase estimates are based on the annual purchase rates for all U.S. households in this income range (12 percent in 2016). The high growth endpoint takes into account the strong likelihood, based on survey evidence, that new job holders will purchase a car. Adding fleet purchases by businesses to accommodate additional employees from job creation would further increase growth in new-car sales. Furthermore, these estimates do not take into account the multiplier effects of the new jobs throughout the economy (on economic growth, jobs and income) that could generate even more new-car sales. For example, the Bureau of Economic Analysis has estimated that between one and three jobs are typically created for each job added, depending on industry. Such additional growth would increase the impact on new-car sales estimated above. This growth would be welcome in a flat market and could well move new-car sales to the next level.
But there is a big caveat attached: whether or not it is possible to achieve 3 percent economic growth with this tax-cut plan in the current economy at full employment. That is, rather than the increased spending from the tax cuts resulting in more jobs, we could just see higher prices if employers struggle to find workers to meet the additional demand. Other issues that could hinder growth include the Federal Reserve raising interest rates to keep any inflation generated by additional growth in check and growth in the national debt if the shortfall in tax revenues is not made up elsewhere. Based on these concerns, some economists would lower the impact on economic growth an additional 0.3 to 0.5 of a percentage point. Economic growth at these lower estimates would result in new-car sales growth of 0.2 percent to 1.6 percent using the methodology described above.
These findings call into question how much impact the tax cuts will have on new-car sales. In any case, given that tax rates and brackets are already set for 2017, any effect on new-car sales won't occur until 2018 at the earliest, if the new plan gets approved this year.
Likelihood of Implementation: Moderate, With Adjustments
Tax cuts were a key promise during the Trump campaign, reiterated with Trump's recent announcement of his plan, and it is likely that the White House will continue to maintain tax cuts as a high priority. The challenge for implementation will come with getting the plan through Congress. While Republicans generally support the idea of tax reform, and in fact had proposed a tax-cut plan last summer, fiscal conservatives as well as Democrats will likely oppose Trump's plan if it does not adequately address the resulting revenue deficit. (Generally, members of both parties reject Trump's claims that the cuts will pay for themselves in terms of added taxes from revenue growth.) If Trump can overcome this hurdle, the likelihood that his tax cuts will be adopted increases substantially.
For additional Edmunds commentary on the impact of Trump's policies on new-car sales:
Peak Auto Sales Still to Come | Beyond Roads and Bridges: How Trump's Infrastructure Spending Plan Could Grow Auto Sales | Trump's Tariffs Could Import a Big Hit to New-Car Sales
Lacey Plache is the chief economist for Edmunds.com. Follow @AutoEconomist on Twitter.