Share |

Corporate Tax Cut May Boost Pay by More Than the $4,000 the White House Claims

Ike Brannon

The most appealing facet of the Republican tax reform plan for
most economists is the reduction in the corporate income-tax rate
from 35% — nearly the highest in the world — to just
20%. Economic theory suggests that a lower tax on corporate income
— or capital income in general — should result in more
domestic investment, which in turn should increase productivity,
wages, and economic activity.

Of course, we would like to know precisely how much wages and
economic growth will increase for our corporate tax cut, but the
data don’t give us a cut-and-dried answer. A few people have taken
stabs at it, and some of those attempts have been attacked as
unduly partisan or wildly optimistic. For instance, Kevin Hassett, chair of the President’s Council of
Economic Advisers
, came under fire for saying that reducing the
corporate income tax to 20% would increase annual income by
$4,000.

Before it became open season on anyone attempting to answer such
a complicated question, Marquette University economics professor Andrew
Hanson and I tried to shed some light on the question simply by
looking at a host of academic studies that had estimated the
relationship between corporate taxes and income.

American workers will
benefit from higher wages and employment if there is a sensible
reduction in the corporate tax rate.

We faced a basic problem in the exercise: The U.S. has scarcely
changed its corporate income tax since 1986 (the sole change was a
one percentage point increase in 1993), which means that we could
not use national data to answer the question. If there is no
variation in tax rates then there is no way to discern any
relationship between rates and income.

Instead, we looked for studies that examined corporate tax rate
changes across the 50 U.S. states or else across other countries
that belong to the Organization of Economic Cooperation and
Development. Over the last three decades, there have been numerous
corporate-tax-rate changes across the states, and we tallied over
100 corporate tax rate changes in OECD countries since 2000 —
nearly every one of which has been a tax-rate reduction.

We found a half-dozen studies we thought were sufficiently
rigorous. Each attempted to estimate the relationship between
corporate-tax-rate changes and wage changes and to control for
other factors that may have influenced pay.

There was some variation in the results across the studies, but
each one found that a lower corporate tax rate boosts income.

We aggregated across these studies to create a rough interval
estimate. For the corporate-rate cut Congress is contemplating, our
data predicts a wage increase between 16% and 28% spread out over
several years. A 20% wage increase, which is in the lower end of
our interval, translates to an additional long-run wage increase of
$16,000, well above Hassett’s $4,000 estimate.

The number is, no doubt, higher than we can reasonably expect
from a U.S. corporate rate cut: the United States isn’t a state or
a small country operating in a market where goods and workers are
fully mobile across the market. The response that Belgium or
Massachusetts gets from a corporate tax rate cut is more pronounced
than what might occur in the United States.

It’s also a rough estimate and subject to large swings in either
direction. And of course wage gains probably wouldn’t be
distributed equally across all jobs.

Also, the extent to which our economy responds to a corporate
rate reduction depends upon how we finance that cut. Its economic
impact will be greater if it is financed via the elimination of
unproductive tax expenditures or reduced profligate government
spending instead of just incurring higher deficits. State
corporate-rate tax reductions typically has to be balanced by
spending cuts or tax increases elsewhere, but most corporate-rate
reductions in the last 15 years in OECD countries have not been
fully offset.

Economists aren’t great at predicting the future and the data we
have available to us are often of limited use in doing so. However,
there is value in noting that numerous studies suggest that lower
corporate tax rates have boosted wages elsewhere. While we do not
expect anywhere near the wage response we encountered in these
studies, the data demonstrate that American workers will benefit
from higher wages and employment if there is a sensible reduction
in the corporate tax rate.

Ike Brannon is
a visiting fellow at the Cato Institute