Did Corporate Tax Cuts Strengthen Wages? Don’t Believe What You Hear
(Bloomberg Opinion) -- Is the Trump corporate tax cut working? Is it increasing wages and investment?
This debate has raged ever since the corporate cuts were adopted in December 2017. Unfortunately, these questions have mostly provoked confusion over how the tax law is supposed to work.
The supporters of the tax cut are to blame for much of that confusion. In their zeal to rally public and political support, many predicted that benefits from changes to the corporate tax code — including higher wages for workers — would materialize shortly after the bill was signed into law.
Corporate public-relations departments didn’t help. When the tight labor market led businesses to issue one-time employee bonus payments in late 2017 and 2018, many PR executives to credit the tax cuts, adding to misguided arguments.
For their part, opponents of the law have also brought little light to our understanding of the law, while adding much heat. They argue that the cuts aren’t working, partly because corporations are not “using” their tax savings “appropriately.” Last month, for example, economist Paul Krugman “Companies didn’t use their tax breaks to invest more; mainly they used them to buy back their own stock.”
All of this misses the point.
The tax law, which went into effect on Jan. 1, 2018, reduced the corporate tax rate from 35 percent to 21 percent — a 40 percent reduction. The law also allows businesses to write off the full cost of certain investments in the year they are made, rather than deducting them over a number of years. Referred to as “full expensing,” this provision is temporary, and will expire in 2023.
The basic economic argument for how businesses are supposed to react to this is straightforward. The rate cut provides incentives for self-interested companies to earn additional taxable income by allowing them to keep more of it. Businesses respond to these incentives by making additional investments in, say, factories and equipment in the U.S. The full-expensing provision also makes U.S. investment more profitable and therefore more attractive to businesses.
The additional investment will make workers more productive, because they can produce more output with more capital. More productive workers are more valuable to businesses, which will compete for employees more aggressively. This will drive up wages, as employers try relatively harder to retain their existing workers and to attract new ones (both from other businesses and from outside the labor force).
This economic argument undermines claims from supporters and critics alike.
Bonus payments and wage increases that immediately followed the law’s enactment weren’t driven by the friendlier treatment of investment, because not enough time had passed for new investments to be made and worker productivity to increase. And the idea was never that the tax cuts would create a pool of money that could be allocated to workers or shareholders or new investment.
The use of immediate tax savings on past investments is beside the point. Instead, businesses will make additional investments in the future in anticipation of larger tax savings on those investments.
There’s plenty of real-world nuance to this simple story, of course.
How sensitive is investment to capital costs and depreciation rates? Some portion of corporate profits are generated by investment activities, and therefore responsive to changes in their tax treatment. But sometimes businesses make profit because of rents, like the loyalty some customers have to a particular brand name. How important is the latter? How long will it take for investment to pick up, and for that to increase productivity, and then for the productivity gains to increase wages? Perhaps most important, by how much should we expect wages to rise? Economists disagree on these issues.
It’s too early to tell whether the corporate tax cuts are working. As has been widely discussed, wage growth is finally accelerating, with a showing in 2018 than 2017. The tax law may have affected wages, but not through the investment-productivity-wages channel I discussed above. (Again, not enough time has passed.) In addition to their impact on that longer-term process, the tax cuts provided a deficit-induced, temporary stimulus to the economy that further tightened labor markets.
The first clue to the corporate tax cut’s lasting effects will not be GDP growth or productivity or wages. Instead, the first place to look is investment. And it’s hard to disentangle the investment effect of the 2017 tax law from fiscal stimulus, regulatory reform, the president’s misguided trade policy and action by the Federal Reserve.
Business investment grew in the 5 percent range in 2017. In 2018, it grew at nearly 7 percent. This is a noticeable quickening. Yet investment growth has been in nearly every quarter since the end of 2015, so we should be careful in assigning credit to the tax law too hastily. At the same time, it has probably had some impact.
I believe the tax law will eventually strengthen investment and wages. The basic economic argument — that businesses respond to investment incentives, and that investment will affect productivity and wages — is quite compelling. Economics is sometimes about whether, and sometimes about how much. In this case, keep your eye on the how much. And ignore ideologues on both sides.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”
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