Paltry wage gains, rising deficits two key tax reform concerns

Paltry wage gains, rising deficits two key tax reform concerns
© Greg Nash

The Tax Cuts and Jobs Act, enacted in 2017, cut corporate taxes by hundreds of billions of dollars over the coming decade. Naturally, policymakers and the public want to know whether these tax cuts are working. But how will we know? The answer, in short, is how much wage rates rise and deficits don’t.

To determine who benefits from corporate tax cuts, the first key question is to what degree wage rates rise above what they would have been in the absence of the corporate tax cuts. If they don’t, then the benefits went to shareholders and other investors.

Proponents of corporate tax cuts usually argue that workers bear the burden of the corporate tax and therefore will benefit most from a corporate tax cut.

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If workers bear the full burden of the corporate tax, there will be a corresponding decrease in the rate of return on investment. That decrease is why — under this logic — shareholders do not benefit from the tax cut in the long run.

 

Opponents tend to argue that workers bear only a small portion of the tax. If this is the case, wage rates will respond only modestly to the tax cuts.

As a rough guide, wage rates (including benefits) would need to increase by about one percent above what they otherwise would have been to shift the entire benefit of the corporate tax cuts from shareholders to workers — even more if revenue-raising corporate provisions of the new law scheduled to take effect in the future are delayed or repealed.

The White House Council of Economic Advisers promised even larger benefits, suggesting increases in the wage rate of 5 percent to 11 percent. This range is not backed by historical experience.

More plausible estimates from the Tax Policy Center or the Congressional Budget Office suggest increases in the wage rate ranging from near zero to only one-third of one percent in 2027. These estimates are consistent with a substantial majority of the benefits of the corporate tax cuts accruing to business owners, not workers.

Who is benefitting from the law’s corporate tax cuts today? At present, primarily shareholders. There is no indication of an increase in the wage rate of anything like one percent, but corporations are already paying lower taxes on their profits.

Who will benefit from the corporate tax cuts in the longer run? It will be years before the research starts to come in, so the best estimates of the long-run impact of the legislation are still informed primarily by the research that was available prior to enactment of the Tax Cuts and Jobs Act.

That research suggests that only a small portion of these corporate tax cuts will be shifted to workers. Moreover, most of the worker gains will accrue to more highly paid workers.

Some observers suggest that analysts should look to investment as a metric for whether the tax cuts are working. But this view is incomplete. If a large increase in investment coincides with a small increase in wage rates, then the benefits of the tax cuts will still accrue primarily to business owners, and the promises made about the benefits of the tax cut will not be borne out.

Examining wage rates directly offers a superior approach — one that does not assume a relationship between investment and the average wage and allows for a richer examination of the distribution of wages across workers.

At the same time, higher levels of investment will tend to lead to higher levels of output, or gross domestic product, which can generate additional tax revenues and reduce the cost of the tax cut.

This brings us to the second test for the corporate tax cuts: How large a net revenue loss do they cause? Revenue losses — and the higher deficits that result — require spending cuts or tax increases in the future.

But with those future policies unspecified, it is not possible to say who will bear their costs. Proponents of corporate tax cuts typically assert that they will generate so much additional economic activity that deficits will increase only modestly, if at all. Thus few, if any, offsetting policies will be required.

However, academic research — and estimates from nonpartisan sources based on that research — suggest that the result of the tax cuts will be more red ink.

Wage rates and deficits — not investment and growth — are the key economic tests for the corporate tax cuts in the Tax Cuts and Jobs Act. The impact on wage rates allows for an assessment of whether the gains do, in fact, benefit workers.

The impact on deficits determines how large the as-yet-unspecified cutbacks will be for other populations in the future.

Though it is not surprising, the clear absence of large increases in the wage rate to this point confirms that the benefits of the corporate tax cuts are currently flowing primarily to shareholders, not workers. Will that change in the longer run? We can hope, but the extant research literature offers little reason to believe it will be the case.

Greg Leiserson is director of tax policy and senior economist at the Washington Center for Equitable Growth.