It’s Not Fake News. Corporate Tax Reform Can Deliver Higher Paychecks to Households

Would Cutting Corporate Taxes Raise Workers’ Incomes?

 
The Council of Economic Advisers recently published a report reviewing several academic economic papers studying the incidence of the corporate income tax on worker wages. Over the last decade, a relatively new empirical literature has emerged to study this question, which consistently finds that a significant burden of the corporate income tax is borne by workers. The CEA report specifically cites a study published by the Federal Reserve Bank of Kansas City, and shows that the results from that study imply that a 1 percent increase in the U.S. state corporate income tax rate would lead to about a 0.1 to 0.2 percent decline in average wages. A mechanical application of that result shows that the proposed corporate tax rate cut in the Republican tax plan from 35 to 20 percent (a decline of 42 percent in rates) would lead to an approximately 4 to 8 percent increase in average wages. With average wages at approximately $50,000, as per data from the Bureau of Labor Statistics, this roughly implies a $2000 to $4000 increase in wages.

This analysis has come under a lot of criticism because it sounds implausible that the average household would benefit so much from a corporate rate reduction. While the exact amount of the benefit is obviously debatable, the controversy surrounding the number has also sparked an interesting back-and-forth between economists, policymakers and other individuals following this debate. Here are the basic points that need to be understood as we tackle corporate tax reform.

 
Can a corporate tax cut lead to higher wages?

Yes. While there may be a wide range of estimates about the magnitude of the impact, most studies that have investigated the relationship between corporate tax cuts and wages find a strong negative link. Simply put, higher taxes drive away capital investments from the U.S., which reduces workers’ productivity and lowers their wages.  Workers thereby bear part of the “incidence” of the corporate tax. The empirical research reviewed in the CEA paper quantifies this effect. Some papers find that between 45 and 75 percent of the incidence of the corporate income tax is on workers. An analysis by William Randolph at the Congressional Budget Office puts the number at 70 percent. Government agencies such as the CBO and the Treasury assume a smaller share of the incidence on workers, at 18 to 25 percent. A recent report from the Tax Foundation suggests an incidence closer to 50-50. All of this suggests that workers could get a big boost from corporate tax cuts.

 
How much of an increase in wages could you get?

In terms of dollars, the CEA review suggests an elasticity of -0.1 to -0.2, implying that a 1 percent reduction in the tax rate would lead to an approximate 0.1 to 0.2 percent increase in wages. Some other studies, although not specific to the U.S., also find the elasticity of total wages to total corporate tax revenue near -0.1, while others find elasticities that are larger. The differences in estimates arise because of differences in the data, geographic regions, and time periods covered. While some studies use firm-level data, others use cross-country analysis. Yet others have studied differences across states within a country. As noted in the example in the introduction, if these elasticities apply to the U.S., households could see wage increases that could vary from roughly $2000 (if the elasticity is -0.1) to $4000 or higher in the long run.

 
Theoretically, can a $1 reduction in revenue lead to a more than $1 increase in wages?

This question has intrigued economists and many others reading the report. The CEA report shows that workers would on average gain $2000-$4000, which, with 150 million workers, means an aggregate gain of $300 billion to $600 billion. The static corporate tax revenue loss, however, is only $133 billion. How is it possible to transfer more money to workers than the loss in corporate tax revenue? For a theoretical exposition, see Greg Mankiw’s recent blog and Arnold Harberger’s original 2006 paper, which started the debate about corporate tax incidence in an open economy.

But intuitively, the logic is straightforward: when you cut the corporate rate, the burden of taxation on firms and workers goes down. Some papers suggest that this might lead to a direct increase in wages if workers have greater bargaining power and are able to claim some share of the higher after-tax profits. But the more interesting impacts occur over the longer term.

Firms that already plan to invest in the U.S. will expand their investments, contributing to a higher capital stock, higher worker productivity and higher wages. Moreover, in a globalized economy there is an additional international investment effect. As recent empirical evidence suggests, multinational firms deciding where to locate their investments will more likely invest in a relatively lower tax country. These pressures are intensified in open economy settings where global capital is highly mobile. An increase in multinational investment in the U.S. increases the demand for workers, leading to an increase in wages.

However, all of these effects are likely to take time, and therefore the wage increases will take years to materialize. But the actual impact on worker wages is not just the mechanical reduction in the share of the tax borne by workers; it also includes the economic changes that a more competitive U.S. economy would bring. So it is indeed possible that the benefit to workers of a $1 loss in corporate tax revenue is more than just $1 in the long-run, through a reduction in what economists call the “deadweight loss” of a tax.

 
Could families actually get $4000 more in their paychecks at some point?

While the empirical literature suggests this is indeed possible, in practice a lot would depend upon how the overall tax package is framed, not just the corporate tax cut. If the tax package adds $1.5 trillion to the government debt, the additional debt will crowd out private investment, reduce the growth impact and limit the wage increase. Moreover, a deficit-financed tax cut may increase the likelihood of a tax increase at some point, which may create uncertainty and discourage investment and hiring. In addition, if other aspects of the tax package constrain investment or hit middle class households, then household incomes may not increase significantly.

Further, it would also depend upon the types of investments that are made, the types of jobs that are created and whether workers are readily able to match with these positions or upgrade their skills sufficiently to match productively with the new capital investments. So a lot needs to fall into place for us to reap the full benefits of moving the U.S. corporate tax code to one that is more in line with the rest of the developed world. But while it may seem out of reach, we owe it to ourselves to adopt the right set of policies that will get us there.

It’s not surprising that there is a tremendous amount of skepticism about the promise of corporate tax reform. After all, we haven’t had a major change to the corporate tax code for almost 30 years, so we cannot be sure about what to expect from such a move. Further, since the U.S. is a large economy, the international investment impact of corporate tax reform may be lower, though clearly not negligible, relative to small countries like Ireland and Switzerland. I think the best approach is to be cautious and to proceed down this path in a manner that opens up the most possibilities for our workers and for our economy. Evidence from around the world suggests that countries that do so tend to help middle class workers through higher wages. As a country, we are all invested in the goal of helping working families. A corporate tax rate cut is a policy that might help us get there. Let’s do it right.

 
• Would Cutting Corporate Taxes Raise Workers’ Incomes?
The Issue:
Although many details of tax reform are still to be fleshed out, lowering the corporate income tax rate from 35 percent to 20 percent is a central component of the proposals by Congressional Republicans and the Trump Administration. A recent report by the Trump administration’s Council of Economic Advisers claims that such a reduction would ”

increase household income in the United States by, very conservatively, $4,000 annually.” This claim sparked intense debate among economists in the blogosphere and the media.

The Facts:

• The U.S. corporate income statutory tax rate is among the highest of all advanced economies. U.S. companies face a statutory federal income tax rate of 35 percent as well as a smaller percentage in additional state taxes that vary by state. Unlike many other countries, the United States also taxes the foreign income of U.S. multinationals (allowing a foreign tax credit for taxes levied abroad). Some critics contend that this tax regime reduces the amount of business investment and expansion, and limits the amount of foreign earnings that are used for domestic investment in the United States (see this EconoFact memo for details).
• The effective tax rate that companies actually pay is lower than the statutory rate, after taking into account deductions and incentives, as well as strategies companies use to reduce their tax burden. Similarly, very little foreign income is actually taxed by the U.S. government. This is partly due to the fact that U.S. tax is not due until repatriation. As a consequence, U.S. multinational companies have stockpiled $2.6 trillion dollars abroad, since they are reluctant to repatriate income to shareholders unless they can gain more favorable tax treatment.
• The C.E.A. report hypothesizes that lowering corporate taxes would raise U.S. wages through a chain of three effects: first, the lower effective tax rate boosts investment; then, the increased investment raises the productivity of labor; and, finally, workers get higher wages as they become more productive. There are important reasons to doubt that these mechanisms will be particularly strong at present, and there is little empirical evidence to suggest that these effects will contribute much to wages. We look at each of these three links in this chain of logic in turn.
• There are reasons to doubt the claims that U.S. investment is substantially lower due to our tax system. In theory, investors who can choose projects across different countries will favor those with lower tax rates, resulting in lower levels of capital per worker in countries with higher corporate tax rates. But, the implications of this theory are diluted once you take into account several real world features. For instance, the current corporate tax system actually subsidizes debt-financed investment because interest paid on debt is tax deductible. (That feature, combined with accelerated depreciation rules, often means that the government is lowering the after-tax costs of investment, relative to the pre-tax cost.) Also, at present, investment is most likely not constrained by low after-tax profits since many of the firms that are targeted by the proposed tax cuts are already earning excess (above-normal) profits. Indeed, economy-wide after-tax profits are at historic highs, and are 50 percent higher (as a share of GDP) this century than they were in the prior decades. And, while U.S. multinationals may be reluctant to repatriate their foreign earnings, they can still borrow against these offshore profits, generating the equivalent of a tax-free repatriation. Moreover, the funds from foreign profits are frequently invested in U.S. assets, increasing the supply of financial capital in U.S. markets.
• Greater investment may not lead to a widespread increase in labor productivity and wages. Even if the corporate rate cut does increase investment, and this investment makes workers who continue to be employed more productive, new machinery, computers, and robots are as likely to displace workers, by lowering labor demand, as they are to increase employment. Indeed, due to increasing automation, manufacturing value added has been rising over the past two decades while manufacturing employment has been simultaneously declining (as documented in this EconoFact memo).
• The link between productivity growth and wages has been weak for the last few decades. Since 1980, GDP per-capita has grown by 60 percent, whereas median household income has only increased by 16 percent. Thus, it may be more difficult in today’s economy for workers to capture productivity gains.
• Overall, it is difficult to document a relationship between lower corporate taxes and higher wages, and the conclusions of the CEA’s report do not represent a consensus view among economists. Some economists, including Jason Furman, Lawrence Summers, and Paul Krugman, found it implausible to argue that for every dollar of corporate tax cut, workers wages would rise by at least $2.50, and perhaps as much as $5.50, as implied by the CEA’s report. Other economists have argued that it is possible for a $1 reduction in corporate taxes to result in a more than $1 increase in wages (see for instance Casey Mulligan and Greg Mankiw), but even most of those economists do not back the wildly optimistic numbers of the CEA report. Some cross-country analyses report a pattern between higher corporate taxes and lower wages, but these studies have some important limitations; I have found no empirical evidence in my own research to support the idea that countries with higher corporate tax rates have lower wages (see here for my findings and a review of existing studies).
• Who bears the brunt of the corporate tax is a topic of legitimate debate among economists. Ultimately, the burden of the corporate tax falls on individuals, but are these individuals the investors and shareholders who earn lower after-tax returns or the employees whose wages are lower? Many of the companies that would be most affected by the proposed tax cuts have been earning above-normal rates of economic profits, due to their market power. Economic theory suggests that taxes on excess profits are borne by shareholders. Several mainstream models, including from the Joint Committee on Taxation, the Congressional Budget Office (pages 17-18), the nonpartisan Tax Policy Center, and (unless recently directed otherwise by this administration) the U.S. Treasury, all conclude that the corporate tax mostly falls on capital or shareholders, with workers only bearing a small minority — typically about 20 percent — of the tax.

 
What this Means:

While there is uncertainty and debate regarding the extent to which lowering statutory corporate taxes to 20 percent might boost worker wages, the CEA’s claim that workers’ income would rise by $4,000 to $9,000 is well above the top of the range of consensus estimates. And one can recount examples of countries that lowered corporate tax rates without a resulting rise in wages, such as the experience of the United Kingdom, which, as a large open economy, is in many ways comparable to the United States. If one goal of tax reform is to raise worker incomes, there are much more direct ways to go about doing so. We know that workers pay all of the payroll tax and that they receive most of the benefit from the Earned Income Tax Credit, so focusing on those areas provides a more direct benefit to workers.

Still, there are good reasons to reform the United States corporate tax system. Ideally, corporate tax reform should not have an adverse effect on government revenue, should reduce distortions that make people respond to tax incentives rather than underlying economic considerations, and should eliminate current incentives that discourage companies from distributing their profits to their shareholders. An ideal corporate tax reform would likely combine a lower tax rate with a broader tax base (including steps to combat profit shifting) and a more even treatment of different types of investment. But deficit-financed corporate tax cuts are more likely to hurt workers than help them.

Πηγές:  American Enterprise Institute, econofact.org