Republicans pitched their tax bill by arguing that cutting corporate rates would boost business investment and eventually lead to higher wages for American workers. Now that the legislation has passed Congress, a number of companies have announced on cue that they are planning to either boost pay, hand out bonuses, or ramp up their investment spending.
These developments have been met by skepticism from Democrats. During the tax debate, liberals, myself included, generally mocked the idea that companies would happily share fatter profits with workers. And many have pointed out that several of the corporations sending out press releases this week touting their investment in their workers have important regulatory issues pending before the Trump administration, and probably need to curry some favor.
The truth is that it’s way too soon to know how and if these cuts will trickle down; we’re going to be debating whether the Trump tax cuts worked for a long, long while. That makes now a good time to offer a very basic primer on how corporate tax cuts are actually supposed to raise wages, and what we should expect to see if this new bill delivers on its promises.
The standard story that economists tell about corporate tax cuts and worker pay is not especially intuitive. It also has nothing to do with corporations generously showering raises on their employees just because they can. Instead, the theory has to do with investment. Cutting the corporate tax rate makes American companies more profitable. That, in turn, should attract money from overseas as investors chase higher returns. Businesses can then be expected to take that cash, and use it for capital investments that will make them more efficient or create money making opportunities—new assembly lines, production robots, AI systems, medical imaging equipment, you name it. As a result of all this high-tech investment, employees should become more productive—which is to say, they’ll generate more revenue for their company per hour of work. As productivity goes up, so should wages. In some cases, companies will be paying more because they’ll be hiring coders and engineers instead of clerical workers and assembly hands. But competitive pressure for labor should also raise wages overall. (None of this is necessarily supposed to affect the total number of jobs out there, mind you; in theory that’s determined macroeconomic factors like interest rates and the size of the potential workforce.)
“It’s not about companies saying oh wow, we got a big tax cut, we’re going to share some of it with our workers. That’s not what the story is,” Tax Policy Center Co-Director Eric Toder told me. “It’s about capital moving to the U.S. and productivity going up.”
To be clear, I am not saying this is the way the world always works. There are serious economists out there who doubt that there is any strong relationship between corporate tax cuts and employee pay at this point, and they’ve raised questions about nearly every step of the narrative that I’ve outlined. Can the U.S. really attract infinite amounts foreign capital? Will companies really invest rather than just spend more on dividends and share buybacks? Is there still a strong link between productivity and pay for all workers?
Once in a while, corporate tax cuts might also lead companies to raise pay for reasons that don’t have anything to do with the productivity narrative. For instance, if a business regularly pays bonuses based on its profitability, and profits go up, then you’d expect bonus season to be more festive. Other employers may realize that they need to raise wages in order to keep up with competitors, but be worried about ticking off shareholders who hate spending money on labor. A tax cut could give those executives space to hike pay. Personally, I have a suspicion that might be why Wells Fargo and Fifth Third Bank are using corporate cuts as an excuse to raise their minimum wage level to $15 per hour. After all, JPMorgan made a similar move in July.
With all that said, the productivity story is the main one that economists tell, and people should keep it in mind as they try to judge whether the Trump cuts are having their supposedly desired effect.
What does that mean in practice? For starters, you should be skeptical every time a company says it’s boosting pay just because the tax cut passed, since that’s really not how all of this is supposed to work. More generally, if wages go up quicker over the next few years, that won’t necessarily be a sign the Trump cuts are working (though the White House will surely treat it that way). The labor market has been getting tighter for a while now, as the economy has finally shaken off the vestiges of the Great Recession. If paychecks start getting fatter faster, it may just be because unemployment is low and companies finally need to compete to keep people on the job.
If we start to see a noticeable jump in corporate investment, however, that might be a sign that the bill Republicans just passed is working as advertised. It could be a hint of other things as well. Some economists think that a tightening job market itself could drive investment and productivity growth as companies look for ways to shave labor costs. Companies could also just think that the economy is strong and now is a good time to spend money to make money. But if there is an investment boom in the near future, and that is then followed by faster wage gains, it would at least open up the possibility that the Trump cuts are doing some good.
In short: If you want to know whether tax cuts are boosting wages, you can’t just track wages. You also have to keep an eye on corporate investment, too. If one goes up but not the other, it means the tax cuts probably aren’t working the way they’re supposed to, at least in the textbooks.
Got it? Now get ready to argue about all this stuff for the next ten years.
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