December 03, 2023
The revisions to the third quarter growth data were striking. After an initial report showing GDP grew at a very strong 4.9 percent annual rate, the revised data show growth was actually somewhat faster at 5.2 percent.
No one expects the economy to sustain anything like this rate of growth going forward. Most likely the growth rate will fall back somewhere close to the 2.0 percent pace that is generally viewed as the sustainable rate, but many economists were projecting a recession this year. It’s clear the economy was not listening to these projections.
Most aspects of the economy look very good right now. Job growth is continuing at a healthy pace. Wage growth has moderated, but it is outpacing inflation. And, we are seeing an extraordinary boom in factory construction as a result of the Inflation Reduction Act and CHIPS Act, laying the basis for a future surge in manufacturing.
However, one aspect remains troubling. The profit share of national income rose sharply in the pandemic, and it continues to be elevated compared to pre-pandemic levels, which were already considerably higher than the profit shares at the start of the century.
We can argue about the cause of the rise in the profit share, but the fact that it has risen is not really in dispute. Here’s the picture since 2018.
Source: Bureau of Economic Analysis and author’s calculations (see text).
These data are taken from the Bureau of Economic Analysis (BEA). There are always difficulties in measurement, and the shares will be revised when the BEA does comprehensive revisions next summer, but for now, these are the best data available.
The profit share jumped early in the pandemic recovery, going from an average of 24.1 percent of income in the corporate sector to 26.8 percent in the third quarter of 2020. It peaked at 27.0 percent in the second quarter of 2022. The rise in profit shares is clearly what drove inflation, just as an accounting matter. It doesn’t make sense to say that wages are driving inflation if they are not even keeping pace with prices, which was true in most of 2022.
I had hoped that as the impact of the Covid pandemic lessened, and supply chains normalized, that we would see the profit share return to its pre-pandemic level. I was not alone in this hope, the Congressional Budget Office projected that profits would fall by 6.7 percent from fiscal year 2022 to fiscal year 2023.
That proved not to be the case. Instead, profits increased by 13.1 percent, and the profit share rose from 26.1 percent to 26.8 percent. This is both surprising and disturbing. It means that whatever factors allowed corporations to increase their profit margins during the pandemic were still allowing them to maintain elevated profit margins even as the impact of the pandemic subsided.
Again, the reasons for why profit margins have increased can be debated, but not the fact that they have increased. The Biden administration has been calling attention to this with recent comments by President Biden and other members of his administration.
While it’s not clear that his haranguing of corporations for excessive margins will affect their behavior, it is still worth calling attention to the issue. First, everyone should be clear (especially Jerome Powell and the Fed) that inflation is not a problem of excessive wage growth.
In fact, we should expect wage growth to exceed inflation by a larger than normal amount for a period of time to at least restore profit margins to their pre-pandemic level. It would not be unreasonable to think that we could get margins back to their 2000 level, but getting back to the pre-pandemic level would at least be a good start.
Second, workers should understand that they can demand higher pay because companies have the money. We saw this story clearly with the UAW strike. The Big Three automakers started with stingy offers, claiming that their backs were against the wall. The UAW held out and insisted that they get a decent contract restoring wage cuts they had accepted in hard times. This resulted in a contract where they got pay increases of close to 30 percent, with larger increases for lower-paid workers.
Third, it is important that the public be clear on the cause of the problem. They can blame or not blame politicians as they like, but what has changed over the last four years since the pandemic is that companies have increased their profit margins. It is understandable they would do this, corporations are in business to make a profit, but this is where the money went. We should all be clear on that fact.
Corporate Tax Rates Have Risen Sharply
While the high profit share can be seen as bad news, there is a positive part of the story that has not gotten the attention it deserves. For reasons that I don’t understand, the share of corporate profits going to pay taxes has risen under the Biden administration.
Trump cut the corporate tax rate from 35 percent to 21 percent in his 2017 tax cut. This led to a drop in the share of corporate profits going to taxes from around 18 percent to just over 13 percent. The share began to rise in the second half of 2021 and has averaged 17.7 percent over the last four quarters.
This is not obviously attributable to legislated increases in tax rates. There was a 1.0 percent tax on share buybacks included in the Inflation Reduction Act, which took effect at the start of this year. While this is great policy, it cannot plausibly explain much of the rise in corporate taxes over the last two years.
It is possible that greater enforcement has played an important role here. The Trump administration seemed to view tax evasion as a sport that was all fun and games. If a Biden I.R.S. decided that laws actually should be enforced, and taxes are not voluntary, that may have had a big impact on tax collections.
I’m sure there are people that have more insight into the causes of the increase in corporate tax payments, who can give a fuller picture. In any case, it is a big deal and the Biden administration deserves some serious credit here.
 This calculation takes the net operating surplus (Table 1.14, Line 8) minus the profits of Federal Reserve Banks (Table 6.16D, Line 11) over the combination of compensation of employees (Table 1.14, Line 4) plus net operating surplus. The after-tax line subtracts out taxes from this sum (Table 1.14, Line 12).