The jobs market looks good under Trump but not because of tax cuts

The jobs market looks good under Trump but not because of tax cuts
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For the most part, the January jobs report numbers spell good news for the economy. Among the highlights, the U.S. economy added 200,000 jobs across both goods-producing and service-providing industries. Average wages have risen 2.9 percent over the past year, and the most recent months show an acceleration at an annualized pace of more than 4 percent. Much of this headway results from the economy’s slow but steady recovery from the Great Recession.

But this month, the conversation will center on something far bigger than the actual numbers. This report marks the first report to have come out since President TrumpDonald John TrumpNASA exec leading moon mission quits weeks after appointment The Hill's Morning Report — After contentious week, Trump heads for Japan Frustration boils over with Senate's 'legislative graveyard' MORE and Congress passed the tax cuts. And if he has yet to do so, expect Trump to tweet about and tie these encouraging numbers to the tax cuts. But buyer beware because if we pause to consider some of the ways in which tax cuts can affect the economy, their limitations become more apparent.

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First, most of the tax cuts go to high-income households, but this cohort does little to stimulate the demand side of the economy. The most costly elements of the tax cut package come from the reductions to individual income rates and corporate rates. These cuts most benefit the highest-income households since many lower to middle-income households do not pay any federal income taxes.

When a higher-income household enjoys a lower tax bill, those people save a good portion of their extra income rather than spend it. That general refrain from consumption limits potential increases in consumer demand, business output, and jobs. As a result, tax cuts that go disproportionately to the wealthy have a lower “multiplier” effect on the economy than do tax cuts or transfers that go directly to lower-income households.

Second, the tax cut “spigot” will take time to flow and will inevitably run off in different and unpredictable directions. Before the tax cut can stimulate the economy, it first must show up in people’s bank accounts or at least in their heads. The first literal dollar flows of the tax cuts come from reduced individual income taxes withheld from worker paychecks, and those withholding amounts have yet to be adjusted.

Businesses will not see literal tax cuts right away but can still incorporate lower anticipated 2018 taxes owed into their hiring and compensation decisions. But many options exist for how businesses can choose to spend their tax cuts. Moreover, they don’t get larger tax cuts for creating more jobs, so there’s no reason why much of a tax dollar saved by a business can be expected to end up in worker paychecks, no matter the claims we will hear.

Finally, the “supply side” effects of tax cuts take the longest time of all, and the effects are usually small. Economic theory says that the reduction of tax rates should increase the incentives of people to work and to save. But in the real world, it turns out that people are slow or simply unable to adjust their work in response to lower tax rates.

Perhaps even more damaging to the likelihood of supply-side responses to tax rate cuts is that it turns out most people don’t even know what the marginal tax rate they face is, especially in real time during the year, rather than in retrospect as they calculate and file their taxes. As a result, they can’t possibly be intentionally responding to it when making their economic decisions.

The U.S. labor market is doing pretty well these days, and the new tax cuts are making people and businesses pretty happy. But we shouldn’t assume that’s very much more than a coincidence. Tax cuts don’t cause jobs, even if the people and businesses that happen to benefit from tax cuts create the jobs.

Diane Lim is principal economist of The Conference Board. She served as chief economist of the House Budget Committee from 2007 to 2008.