A talking point that I’ve seen recently is that lower tax rates will lead to higher wages. I’ve done a quick search, but couldn’t find any real studies that graph corporate tax rates vs wages by country. So, if someone knows of such a study, please share.
Leaving aside tiny tax havens, I don’t even understand how it’s supposed to work even in principle. A lower corporate tax rate means that higher wages cost more after taxes. For example, if the corporate tax rate were 80%, the marginal cost of an extra dollar of wages is only 20 cents. So, if the company thinks it can get more than 20 cents of extra income by paying that extra dollar, then it’s worth it. However, if the tax rate were 15%, the additional dollar has to bring in more than 85 cents of additional income to be worth it. So, the marginal cost of wages goes up as tax rates come down.
Does that make sense? If not, where did I go wrong?
If, however, the argument is a trickle down argument that lower tax rates will lead to more economic growth, even in our full employment world, please leave that argument to some other thread. The Fed would raise rates to counteract that kind of stimulus anyway, if it even worked as stimulus.
Unfortunately, I’m on my way to work, where I’m not supposed get on message boards, so I’ll be somewhat quiet for a while, but I’ll definitely check back in later.
Here’s a quote from an article I read recently that prompted the thread. It wasn’t much of an argument, just a talking point:
[QUOTE=NY Article]
Well, let me first take you up on the point of agreement. C.E.O.’s of large companies will testify that a hefty share of corporate taxes are paid out of their labor costs. So a corporate rate cut is one way to stimulate wage growth that has been stagnant.
[/QUOTE]
Since Republicans are the party of lower taxes, I’ll give two seemingly contradictory statements I sometimes hear from them.
Lower taxes will help businesses grow and create more jobs.
A business is supposed to look out mainly for the shareholders, not the employees. Therefore if any extra profit is made as a result of tax cuts, it’s fine and dandy if that money is used to reward shareholders rather than employees.
I’m not sure how both of those can be true at the same time.
Assume $100 of revenue and $90 in cost per employee. That’s $10 in earnings per employee. Profit in your two tax scenarios is $2 or $8.5.
With low taxes, the company could increase costs by $7.65 and still earn the same profit as in the low tax situation.
But Can != Will
In FreshmanEconLand, wages are somewhat elastic and respond to supply and demand. Expansion costs money. Having more money available facilitates expansion, thus increasing employment, thus driving up wages.
But that’s a just-so story. You want actual data? I’d be surprised if we have any.
Because shareholders are also rewarded when profits are invested back into the business to either expand or pay down debt. The employees benefit by keeping their jobs or possibly growing into more senior roles as the company expands.
In reality, the problem is actually a lot more complex. Certainly business growth is ultimately good for the economy. But not everyone benefits and some people are actually harmed. If you work for an industry that gets “disrupted” or get priced out of an area that is “gentrified” by a sudden influx of tech firms or hedge funds, you don’t really see the benefits. And yet, inconveniently, those people don’t go away.
Interestingly, Conservatives seem like they are in favor of “free trade” unless it involves fossil fuel companies being made obsolete and Liberals seem fine with Silicon Valley tech firms pricing everyone out of the San Francisco Bay Area.
Really? So how does a business ever grow if it exclusively gave any “extra” money back to shareholders? Or, why would any company ever give a raise to anyone, rather than pay the money to shareholders?
In general, businesses pay employees no more than they have to. That applies to any business cost. There’s no direct relationship between lower corporate taxes and higher wages, or high corporate profits and higher wages either. An increase in the net from lower taxes could raise dividends, increase investment, increase payroll with more employees instead of higher wages, increase benefits, be stockpiled in cash, or be pissed away.
Thanks. I won’t click on Forbes links, but the Tax Foundation makes a tax –> growth –> wages argument. It’s long though so I’ll need to spend some more time with it.
I don’t think your math works. The part that stands out is the marginal cost of wages doesn’t equal the inverse percent of the tax rate. Here’s your example illustrated:
A Tax Rate 80% 80%
B Revenue 100.00 100.20
C Wages 80.00 81.00
D Income 20.00 19.20
E Tax 16.00 15.36
F Net 4.00 3.84
Getting the alignment right isn’t super easy, but basically in the above:
D= (B-C)
E = (A*D)
F=(D-E)
You can see that comparing the two, an increase of $0.20 of revenue with an increase of wages of $1 does not yield the same net income result. I could have misunderstood your example.
One of the arguments in favor of lowering taxes is that business activity designed primarily to reduce tax burden is inefficient. Tax minimization strategies can lead to business decisions that would not otherwise be made which creates noise. If the ROI on a tax strategy is 50% it could make sense to do some very creative things. If that same strategy has an ROI of only 3%, maybe simply paying the extra tax is worthwhile since the administrative burden to embark is too great.
There’s no reason to think a graph of wages by country v corp tax rate would be useful unless somebody were claiming that corporate tax rate was the only or at least dominant factor in the general level of wages, which nobody does. Obviously factors beside taxation make the wage levels in Ireland and the US (more or less the poles of low and high nominal corp tax rates in the developed world) relatively similar compared to poor countries of all tax rates, ones even without any corporate tax. Stuff like strong rule of law wrt property rights, capital per worker, general cultural tradition etc. dwarf the effect of corporate taxation policy if you consider all countries.
And even among rich countries other factors could vary importantly. The question is whether a drop in nominal corporate tax rate in a given country would affect the wage level. Even if some people try to correct for other differences, seems to me a cross sectional analysis of different countries is inherently difficult.
Your analysis isn’t wrong IMO, however what it misses is looking at just one element of expense rather than the whole picture. The catch isn’t that expenses cost more after tax at the lower rate (though that’s true), because revenues are more attractive after tax at the lower rate and revenues are excepted to exceed expenses. Companies where that’s consistently untrue will eventually disappear under either tax rate.
The potential catch is the effect of making up somewhere else the revenue lost from the lower rate, under the assumption that increased pre tax profit (from more economic activity) isn’t enough to keep revenue constant. Which it probably wouldn’t be under the assumption of a plain cut in the rate. Again though if you make other changes to reduce the complexity or tax revenue and expense differently* the lower nominal rate might not reduce revenue.
Focusing on wages specifically, a corporate income tax is an inherently ambiguous tax on some combination of the sales of a company, the wages of employees and the after tax return of owners. It’s enacted under the populist assumption it’s a tax on the owners, although usually stated as ‘a tax on the companies themselves’ but that makes no sense. ‘Companies’ can’t pay taxes, only people, eventually. Economists debate what’s called the ‘incidence’ of that tax. Some think it’s relatively accurate to think of it as a tax on the owners (they claim to prove that’s true theoretically in a closed national system…but the modern globalized economy is not close to that). Others think that’s seriously inaccurate, and a substantial amount of the tax is really on wages (of employees) and prices (to customers of the companies).
IMO the corporate tax is a stupid idea just given that nobody can say for sure who is actually paying it. And, if you wanted to just raise taxes on return on capital (albeit another probably stupid idea given the joint slow down in growth in capital per worker and wages in the US in recent decades), you could do that directly at the individual level, when the owners receive the return in dividends or sale of their ownership. Almost surely better though to tax consumption, which you can do at a progressive rate by simply allowing unlimited income tax deduction for capital returns which are reinvested (ie saved) and not spent on consumption, then have quite tax rates, if desired, on high levels of income-minus-savings.
*assuming it’s just a tax cut under the same system otherwise. For example the proposed ‘border adjusted cashflow tax’ in the US would tax some forms of business on a much broader base of revenue than now (expense of imported inputs not deductible anymore), the reason that proposal is in such political trouble. Companies which mainly retail imported goods, and their political backers, don’t like that idea, don’t believe other changes (foreign currencies should get cheaper in $'s if you do that) would offset the higher tax on them. Anyway once you start changing other major things, you can’t just focus on the effect of the rate change.
This paper [1] did a study of 55,000 companies in Europe and found that 75% of a corporate tax increase is, in effect, paid for by loss of wages.
[1] Arulampalam, Wiji, Michael P. Devereux, and Giorgia Maffini. “The direct incidence of corporate income tax on wages.” European Economic Review 56.6 (2012): 1038-1054.
I may have the math wrong somewhere, but the larger point remains. At an 80% tax rate, a dollar raise, with a 20 cent income increase, reduces the net number by 16 cents. At a 20% tax rate, the same dollar raise with the same 20 income increase reduces the net number by 64 cents. So, the company would be not have an incentive to raise incomes in a low tax environment since the after-tax result is much worse than in a high tax environment.
I agree that there are other confounding factors and reasons why tax rates should be higher or lower, but the articles I cited all refer to lower tax rates leading to higher wages. I take issue with that statement.
Yeah, it’s pretty much supply and demand. If the economy is growing and jobs are being created faster than employees are popping up, then wages are going to go up. And by “economy”, I mean the whole thing or any subset of it. Where I live, the economy is going like gangbusters, but it’s software and electronics, not furniture or clothing manufacturing.
If cutting corporate taxes is good for the economy, then it should (indirectly) be good for wages, but extra $$ to the corporation isn’t automatically going to increased wages.
Tax incidence theory states that tax burdens fall heaviest on things that are hardest to move. Labor is hard to move and capital is cheap to move. For instance if the state I live in raises taxes on labor to avoid it I have to sell my house, get a new job, find a new house, etc. However if a state I invest in raises taxes I can call my investment guy and have him sell the investment and buy a new one in another state. Thus capital goes to where it is taxed the least. Since capital and labor are complimentary, a guy operating a backhoe makes more than a guy with a shovel, lower taxes on capital means more productive and higher paid workers. Hereis a study that says manufacturing wages are inversely related to corporate taxes in different countries. Hereis study that found a 10% increase in corporate taxes was associated with a 7% decrease in mean annual gross wages.
I don’t think the point remains actually. If you hold all things constant then perhaps this makes sense, but even in your example the argument seems to be that the higher the corporate tax rate, the lower the cost of increasing wages. And while that may be mathematically true as the expense line simply shifts from tax to wages, that’s not at all a realistic model. At a 100% tax rate, the net impact of increasing wages would be zero, but that’s also not realistic.
But looking through the articles, I don’t think you’ve summarized what they are saying accurately. From the NY Times article which you previously quoted:
I don’t think this comment is informative simply because it isn’t fleshed out enough to determine what is being said.
The Tax Foundation article isn’t making the argument that lower tax rates will lead to higher wages per se. The argument from this article is that because capital is more mobile than people, higher corporate tax rates disproportionately impact people who do not have the same mobility as capital. It goes on to say that companies that are growing and need large amounts of capital to expand or improve the business are hurt more by higher corporate taxes than those that are already industry leaders. The article goes on to recommend accelerated depreciation and cessation of taxes on income earned overseas but I don’t think those are related to the point you are trying to make. Overall I think the lower corporate tax argument from the Tax Foundation article is one of increased productivity and leading to higher wages/better results as a whole. A person who has a job where they are at is better off than losing that job when the company relocates to Ireland.
The first Forbes article makes a similar overall argument:
Essentially, if capital remains in the US because it is more competitive with lower corporate tax rates, that could lead to more employment and more jobs in the US. That could lead to increasing the overall economic performance and wages.
I’m having trouble opening the 2nd Forbes article. I hate Forbes.
Thank you for those cites. It will take some time for me to get through them. Reading through the initial abstracts, my impression is that the link between corporate tax rates and wages may be statistically significant, but is a minor part of the story. The theory relies on other factors, like moving capital (as you mention), open borders, and is not as simple as a lower tax rate leading to higher wages – there are many confounding factors, and those factors will be different for large economies vs. small ones, economies operating at full employment vs. underemployment, employee productivity, and so on.
When you read the talking points, the implication seems to be that if you lower corporate taxes, there will be more money for the company and that will go into wages. The reality is quite different, agreed?