Would Cutting Corporate Taxes Raise Workers’ Incomes?

The Issue:

Although many details of tax reform are still to be fleshed out, lowering the corporate income tax rate from 35 percent to 20 percent is a central component of the proposals by Congressional Republicans and the Trump Administration. A recent report by the Trump administration's Council of Economic Advisers claims that such a reduction would "increase household income in the United States by, very conservatively, $4,000 annually." This claim sparked intense debate among economists in the blogosphere and the media.

There is legitimate debate among economists regarding who bears the brunt of the corporate tax.

The Facts:

• The U.S. corporate income statutory tax rate is among the highest of all advanced economies. U.S. companies face a statutory federal income tax rate of 35 percent as well as a smaller percentage in additional state taxes that vary by state. Unlike many other countries, the United States also taxes the foreign income of U.S. multinationals (allowing a foreign tax credit for taxes levied abroad). Some critics contend that this tax regime reduces the amount of business investment and expansion, and limits the amount of foreign earnings that are used for domestic investment in the United States (see this EconoFact memo for details).
• The effective tax rate that companies actually pay is lower than the statutory rate, after taking into account deductions and incentives, as well as strategies companies use to reduce their tax burden. Similarly, very little foreign income is actually taxed by the U.S. government. This is partly due to the fact that U.S. tax is not due until repatriation. As a consequence, U.S. multinational companies have stockpiled $2.6 trillion dollars abroad, since they are reluctant to repatriate income to shareholders unless they can gain more favorable tax treatment.
• The C.E.A. report hypothesizes that lowering corporate taxes would raise U.S. wages through a chain of three effects: first, the lower effective tax rate boosts investment; then, the increased investment raises the productivity of labor; and, finally, workers get higher wages as they become more productive. There are important reasons to doubt that these mechanisms will be particularly strong at present, and there is little empirical evidence to suggest that these effects will contribute much to wages. We look at each of these three links in this chain of logic in turn.
• There are reasons to doubt the claims that U.S. investment is substantially lower due to our tax system. In theory, investors who can choose projects across different countries will favor those with lower tax rates, resulting in lower levels of capital per worker in countries with higher corporate tax rates. But, the implications of this theory are diluted once you take into account several real world features. For instance, the current corporate tax system actually subsidizes debt-financed investment because interest paid on debt is tax deductible. (That feature, combined with accelerated depreciation rules, often means that the government is lowering the after-tax costs of investment, relative to the pre-tax cost.) Also, at present, investment is most likely not constrained by low after-tax profits since many of the firms that are targeted by the proposed tax cuts are already earning excess (above-normal) profits. Indeed, economy-wide after-tax profits are at historic highs, and are 50 percent higher (as a share of GDP) this century than they were in the prior decades. And, while U.S. multinationals may be reluctant to repatriate their foreign earnings, they can still borrow against these offshore profits, generating the equivalent of a tax-free repatriation. Moreover, the funds from foreign profits are frequently invested in U.S. assets, increasing the supply of financial capital in U.S. markets.
• Greater investment may not lead to a widespread increase in labor productivity and wages. Even if the corporate rate cut does increase investment, and this investment makes workers who continue to be employed more productive, new machinery, computers, and robots are as likely to displace workers, by lowering labor demand, as they are to increase employment. Indeed, due to increasing automation, manufacturing value added has been rising over the past two decades while manufacturing employment has been simultaneously declining (as documented in this EconoFact memo).
• The link between productivity growth and wages has been weak for the last few decades. Since 1980, GDP per-capita has grown by 60 percent, whereas median household income has only increased by 16 percent. Thus, it may be more difficult in today’s economy for workers to capture productivity gains.
• Overall, it is difficult to document a relationship between lower corporate taxes and higher wages, and the conclusions of the CEA's report do not represent a consensus view among economists. Some economists, including Jason Furman, Lawrence Summers, and Paul Krugman, found it implausible to argue that for every dollar of corporate tax cut, workers wages would rise by at least $2.50, and perhaps as much as $5.50, as implied by the CEA's report. Other economists have argued that it is possible for a $1 reduction in corporate taxes to result in a more than $1 increase in wages (see for instance Casey Mulligan and Greg Mankiw), but even most of those economists do not back the wildly optimistic numbers of the CEA report. Some cross-country analyses report a pattern between higher corporate taxes and lower wages, but these studies have some important limitations; I have found no empirical evidence in my own research to support the idea that countries with higher corporate tax rates have lower wages (see here for my findings and a review of existing studies).
• Who bears the brunt of the corporate tax is a topic of legitimate debate among economists. Ultimately, the burden of the corporate tax falls on individuals, but are these individuals the investors and shareholders who earn lower after-tax returns or the employees whose wages are lower? Many of the companies that would be most affected by the proposed tax cuts have been earning above-normal rates of economic profits, due to their market power. Economic theory suggests that taxes on excess profits are borne by shareholders. Several mainstream models, including from the Joint Committee on Taxation, the Congressional Budget Office (pages 17-18), the nonpartisan Tax Policy Center, and (unless recently directed otherwise by this administration) the U.S. Treasury, all conclude that the corporate tax mostly falls on capital or shareholders, with workers only bearing a small minority — typically about 20 percent — of the tax.