The President’s Council of Economic Advisers claims that slashing the corporate tax rate to 20 percent would boost the average American’s wages by $4,000 per year (“very conservatively”) — and perhaps by as much as $9,000. If true, that would be a remarkable gain for working Americans.
Unfortunately, it’s extraordinarily unlikely to be true.
The two of us can think of dozens of objections to the CEA claim, presented in an official report, but perhaps the place to start is with the United Kingdom, which has already run this experiment. Over the past decade, the United Kingdom has slashed its corporate tax rate, in several steps, from 30 percent down to 19 percent. At the same time, the United States has kept its corporate tax rate constant at 35 percent. Like the United States, Britain has a large open economy, investors in British firms come from all over the world, and Britain provides a sound legal and regulatory environment.
So what happened to wages after Britain cut corporate taxes? The following chart tells the story. As UK corporate tax rates fell, so did real (inflation-adjusted) median wages. That is, wages moved in the opposite direction from that predicted by the CEA. Meanwhile, in the United States, real median wages crept up — not quickly enough, but at least moving in the right direction. Even if you start the clock in 2013, after the Great Recession, UK wage growth didn’t keep pace with that of the United States.
Of course, the UK example is just one case, but this comparison is a great deal more relevant to the CEA’s claims than the slapdash comparison it presents near the start of its report. The report compares US wage growth over three years to wage growth in 10 unnamed “low-tax” developed economies. But the United States is simply not comparable to small-economy tax havens like Ireland and Switzerland.
What’s more, the CEA comparison focuses on average wage growth, while our chart uses median wages. There’s a good reason we do so: The median wage actually shows the experience of workers in the middle of the distribution, whereas average wages are distorted by super-salaries paid at the very top of the income spectrum. The rise or fall of average wages tells us nothing about what’s happening to the typical worker.
The CEA report also implied astounding payoffs to tax reductions, such that every dollar of corporate tax cuts increases US wages by well over $2.50, a literally incredible increase. Their plan to cut corporate taxes by about $200 billion annually is meant to yield a total wage increase of $550 billion to $1.1 trillion each year, if you multiply their assumed wage gains by the number of households in the economy.
The CEA report draws on outlier research, some of it unpublished
More important, the work that the CEA cites in defense of its wage estimates is a group of (typically unpublished) papers that have been challenged by subsequent critiques. Their highly selective use of the literature to back their claims is unusual for the CEA, which typically adheres to rigorous standards for fact-checking and evidence.
A more exhaustive overview of the literature in this area would show that most studies fail to provide convincing cross-country evidence indicating that countries that lower corporate taxes will experience greater investment and wage growth.
The models used by the Congressional Budget Office, the Joint Committee on Taxation, the US Treasury Department (unless it has just now been directed to do otherwise), and the nonpartisan Tax Policy Center all assign the vast majority of the burden of the corporate tax to shareholders or investors more generally, not to workers. In other words, a corporate tax cut would benefit investors and shareholders, with only a small effect on wages. These institutions all formed their assumptions after a careful review of the evidence.
Why would anyone think slashing corporate tax rates would increase workers’ wages in the first place? The theory endorsed by the CEA relies on three steps to get from corporate tax cuts to higher wages. First, the corporate tax cut increases companies’ after-tax returns on investment. As a result, firms will make more investments in plant and equipment than they would in a higher-tax-rate environment. Second, greater investment by firms leads to higher productivity by the workers who put those investments to work. Third and finally, workers will receive increased wages in line with those productivity gains.
Unfortunately, this theory just doesn’t map onto today’s reality. For one thing, it is doubtful corporate investment would increase. Today’s corporate investments are not unduly burdened by taxes. In fact, quite the opposite. Thanks to the intersection of different tax preferences, the effective (real-world) corporate tax rate on debt-financed investments in equipment today is negative. That means taxpayers as a whole already subsidize these investments. Moreover, there is no evidence that companies today are capital constrained — interest rates remain near record lows, and credit is plentiful. Companies like Apple find it trivial to raise large sums via borrowing.
Beyond this, the administration’s tax cut proposal is coupled with a territorial tax system, which permanently exempts foreign income from taxation; this will further tilt the playing field in favor of foreign, rather than US, investment. The CEA’s argument for wage increases is based on an enormous amount of new investment occurring in the United States, yet the administration also proposes to simultaneously cut US taxes on foreign income to zero. (Previously, foreign income was taxable in the United States upon repatriation.)
The link between actual corporate investment and workers’ wages is far from obvious
Even if a burst of new US investments were to occur, it is unclear that more investments in computers and robots would increase overall demand for labor. While the workers left operating the machines might be more productive than they were previously, such investments also displace current workers.
We also have a great deal of data on productivity gains versus wage growth. The two were closely linked for decades, but since about 1980 they have diverged, with wage growth falling far behind productivity growth, for reasons having nothing to do with corporate tax burdens. This means investors are capturing an ever-increasing share of productivity gains at the expense of workers. The CEA paper acknowledges that this problem has existed in the recent past, but then assumes it will disappear. But it is unclear why the proposed tax cuts will provide the magic elixir required for higher productivity to translate into wage gains.
Finally, America’s most successful firms already capture economic returns far greater than that required to make their investments worthwhile. (Economists call these supersized returns “economic rents.”) Reducing the corporate tax rate provides a windfall to investors in those firms, but it does not lead to greater investment. In fact, taxing supersized returns does not distort investment at all, since investment decisions are not affected by taxes on rents. So, the benefits from cutting the tax rate on economic profits in these cases redound entirely to shareholders.
The US corporate tax system is in need of genuine reform, and that may well include a lower statutory rate. But tax reform should not be perverted into a tax windfall for capital owners on the pretense that it’s good for the working man.
Kimberly Clausing is the Thormund A. Miller and Walter Mintz professor of economics at Reed College. Edward Kleinbard is the Robert C. Packard trustee chair in law, University of Southern California Gould School of Law. He is a former chief of staff for the US Congress Joint Committee on Taxation, and author of We Are Better Than This: How Government Should Spend Our Money.
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