October 16, 2017
The White House is pushing the line that their proposed cut to corporate tax rates will lead to an increase in average household income of more than $4,000.
“Reducing the statutory federal corporate tax rate from 35 to 20 percent would, the analysis below suggests, increase average household income in the United States by, very conservatively, $4,000 annually. The increases recur each year, and the estimated total value of corporate tax reform for the average U.S. household is therefore substantially higher than $4,000. Moreover, the broad range of results in the literature suggests that over a decade, this effect could be much larger.”
This is a pretty impressive claim, but it gets even better a couple of pages later:
“When we use the more optimistic estimates from the literature, wage boosts are over $9,000 for the average U.S. household.”
There are few things worth pointing out about the White House’s claims here. First, the idea that workers would see large gains from a reduction in corporate income tax rates is not based on the idea that lower taxes will be directly passed on in wages. The amount of tax at stake is far too small to have the sort of impact on wages claimed here.
Rather the implication is that there would be a huge burst of investment leading to a huge increase in productivity and growth. The higher levels of productivity would be passed on to workers in the form of higher wages.
To get an idea of the size of this burst, the $4,000 figure is just under a 5 percent boost in income, whereas the $9,000 figure is more than an 11 percent increase. This means we need to see an increment to growth of roughly this amount over the near future, presumably the next four to five years.[1] This also means we’re talking about adding more than a percentage point to the annual growth rate in their less optimistic scenario and more than two percentage points in their high-end estimate. We have never seen anything like this from a change in tax policy — but hey, anything can happen.
It is worth noting that there is a large literature that has examined the incidence of the corporate income tax and comes to the opposite conclusion: that it has little effect on growth and it is borne mostly by capital. This literature is summarized in a Treasury Department paper from a few years ago, which has recently been disappeared from the website.
The literature showing that a cut in corporate income taxes would have a large impact on wages does have some interesting implications other than the implied huge surge to growth. For example, one paper finds that openness to trade has a large negative impact on wages. In one specification, a one percentage point increase in openness would lower wages by 0.48 percent.[2] Since the U.S. economy has become roughly 7.0 percentage points more open over the last four decades, this would imply a loss in wages due to increased trade of roughly 3.4 percent or more than $1,500 a year for the median full-time worker. That’s a big hit from trade, if true.
It’s also worth noting that we already have seen a large reduction in average tax rates over the last four decades. In the late 1970s, corporations paid more than 36 percent of their profits in corporate income taxes. In the last three years, they have paid a bit over 23 percent. And of course, investment has remained weak in spite of this sharp reduction in effective tax rates. Sure, it may be different if we cut the tax bite even further, but why would we think this?
It’s also worth noting that the basic premise of the CEA paper, that workers can’t get their share of growth in the economy as now structured is wrong. The piece tells readers:
“But even as Americans’ real wages stagnated, real corporate profits soared, increasing by an average of 11 percent per year. The relationship between corporate profits and worker compensation broke down in the late 1980s. Prior to 1990, worker wages rose by more than 1 percent for every 1 percent increase in corporate profits. From 1990-2016, the pass-through to workers was only 0.6 percent, and looking most recently, from 2008-2016, only 0.3 percent.”
This is some very selective picking of years here. From 1980 to 2001 (the 1990s business cycle) nominal profits rose by 80.7 percent, nominal labor compensation (wages plus benefits) rose by 80.9 percent. In other words, there was no disconnect between wages and profit growth in the 1990s.[3] And, after having a period in which there was a large shift from wages to profits, mostly associated with the high unemployment of the Great Recession, wages are now actually outpacing profits.
From 2013 through the second quarter of 2017, nominal wages rose by 16.1 percent. By contrast, nominal profits have risen by 4.5 percent. Workers at the middle and bottom of the wage distribution did even better. It looks like if we can just keep the Fed from slamming on the brakes and sending unemployment higher, workers might be able to continue to get their share of the gains from growth and win back some of the losses they incurred in the Great Recession.
In short, it looks like the White House is selling a big cut in the corporate income tax as a fix, based on very poor evidence, for a problem that, at least at the moment, does not exist.
[1] The paper argues explicitly that over a decade the gains would be even greater, so this number is clearly meant to be a near-term effect.
[2] Openness is defined as the combination of the import and export share of GDP.
[3] These data can be found in the National Income and Product Accounts, Table 1.12, Line 2 and Line 13.
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