Do Tax Cuts Mean Wage Rises? Not So Fast
WHY YOU SHOULD CARE
Because in the worst-case scenario, the real wages of an American worker may actually come down.
In the constant cascade of promises that pours from the Trump administration, one of its more recent claims stood out, both for its rare specificity and for its raw, gut-level appeal to low-wage workers across the country. Support the administration’s plan to slash the corporate tax rate, voters were told, and you will be rewarded with a pay raise.
And they weren’t talking about small change. Kevin Hassett, the chairman of the White House’s Council of Economic Advisers, promised that if the business tax rate were cut to 20 percent from its current level of 35 percent, American households would see wages increase by at least $4,000 per year. He went on to suggest that the figure could easily rise to as much as $9,000. In a country where the median household income in 2016 was $59,000, that’s real money to a lot of people.
But don’t start making plans to spend that windfall just yet.
Every link in that chain is shaky.
Jared Bernstein, economist
If Republicans in Washington are successful in slashing the corporate tax rate, the U.S. will become only the latest in a string of advanced economies that have tried to make their tax codes more business-friendly — usually with underwhelming results when it comes to wages. Earlier this year, Josh Bivens and Hunter Blair of the Economic Policy Institute in Washington examined data from OECD countries between 2000 and 2016 and found “no obvious correlation between corporate rate changes and wages.” Germany, which dropped its corporate rate from 42.2 percent in 2000 to 15.8 percent a decade ago, has seen its wages grow at a slower pace than other OECD countries since. The U.K. cut its rates gradually from 30 percent in 2007 to 19 percent today, and according to OECD data, inflation-adjusted wages there are almost exactly what they were a decade ago. And the evidence of disconnect between the productivity growth that reduced corporate taxation is supposed to spark and actual wages has only been growing: A steep tax cut in 1986 in the U.S. did not reduce the gulf between productivity growth and worker wages.
“Every link in that chain is shaky,” says Jared Bernstein, former chief economist to Vice President Joe Biden and now a senior fellow at the left-leaning Center on Budget and Policy Priorities. “The relationship between corporate tax cuts and investment is far weaker than you’d think. The relationship between productivity and wage growth, particularly for middle-wage workers, has seriously broken down.”
On its face, the argument underlying the administration’s claim is fairly straightforward.
A reduced corporate tax would make the U.S. a more attractive investment destination, bringing in capital that in theory should make workers more productive, thereby increasing their wage rate in the labor market, explains economist Alan Viard, a resident scholar at the conservative American Enterprise Institute in Washington.
But even Viard, while generally sympathetic to the idea that a reduction in corporate rates will benefit workers, is reluctant to endorse the specifics of the administration’s claim. Among tax economists, he says, “There is some pretty broad agreement that we expect the corporate rate cut to boost wages to some extent.” However, he added, “I think there would also be agreement that it’s not going to be in the $4,000 to $9,000 range.”
Viard is more inclined to trust an analysis by the Tax Foundation, a conservative-leaning organization in Washington that modeled the effects of the proposal and predicted a percentage increase in worker pay in the low single digits at best.
Others are even less optimistic.
The editors of The Economist, no vector of left-wing policies, complained that the administration’s arguments were not “reasonable,” adding, “There is no clear relationship between recent corporate-tax cuts and wage growth in rich countries.” Former treasury secretary Larry Summers, now at Harvard, said on his blog that if the CEA analysis had been presented to him by a student in one of his economics classes, he would be “hard pressed to give it a passing grade.”
The historical record is “very unfriendly” to the Trump administration’s claims, says Bernstein. “The assumption that the gains will be significant for middle-wage workers is not at all supported by the data.”
Other economists have come to similar conclusions. In 2011, Jane Gravelle and Thomas Hungerford, of the Congressional Research Service, reviewed economic literature on the effect of the corporate tax on wages — including a study authored by now-CEA chair Hassett — and found little support for the idea that wages are significantly affected by business taxes.
But for many economists, there’s something more worrying than just political hyperbole. The end result of this proposed tax cut might be to actually leave workers worse off than they were beforehand. That’s because of how the tax cut is being paid for. Republicans in Congress and the White House are planning to pass their tax cuts without any offsetting spending cuts or revenue increases. That means that the entire cost of the exercise will be covered by more federal borrowing.
That’s something that gives pause to economists like Viard, who would otherwise be relatively enthusiastic about a large corporate tax cut.
“Because this is deficit financed … the combined effect of the corporate rate cut and the debt overhang could actually lower wages,” says Viard. “The corporate cut in isolation would increase wages, but of course the deficit would tend to lower them.”
That would be the worst of all possible outcomes for most taxpayers, who would see their purchasing power eroded as nominal wage growth is outpaced by inflation. And it’s a result that would be especially hard to explain for an administration that rode to power on promises of fatter paychecks and an end to corporate giveaways.
* Correction: In an earlier version of the story, wage rate was misspelled as age rate in one place.