How to Make Companies Share Their Bounty
The theory behind the claim that cutting corporate taxes will increase workers' incomes goes something like this:
The corporate tax should affect labor market outcomes by affecting the distribution of capital investments across countries, and thus capital-to-labor ratios, the marginal product of labor, and wages.
That's from a lucid (and skeptical) 2012 review of the theory and evidence on corporate tax incidence by Reed College economist Kimberly Clausing. If all goes according to theory, then, reducing the corporate income tax rate to 21 percent from 35 percent, as Congress has just done, would lead to more corporate investment in the U.S. That investment would increase the ratio of capital to labor, which would increase the marginal product of labor, which would bring higher wages.
According to this view, it won't be a problem if corporations spend most of the tax break Congress has just granted them on shareholder buybacks. As the Hoover Institution's John Cochrane put it in his blog:
In the end, investment in the whole economy has nothing to do with the financial decisions of individual companies. Investment will increase if the marginal, after-tax, return to investment increases. Lowering the corporate tax rate operates on that marginal incentive to new investments.
That's the theory, at least! As Clausing recounts in her paper, there are other theories of corporate tax incidence in which little or none of the bounty from a corporate tax cut flows to workers. There's even one model, from Nadine Riedel of the University of Bochum, in which raising corporate taxes leads to wage hikes.
I think it's fair to say, though, that the first theory is the most widely accepted among economists at the moment. There is also empirical evidence from cross-country and even cross-municipality surveys that lower corporate taxes are correlated with higher wages. As Clausing explains in detail, these results should be taken with many grains of salt. But again, my impression is that, on balance, the data lends some support to the notion that workers can gain from lower corporate taxes.
This is why, while cutting the corporate rate is possibly the least popular aspect of the new tax law among the public at large, it gets grudging and not-so-grudging support from economists and from the journalists like me who try to understand them. The rate cut is not certain to work as advertised. But the arguments for it are based in economic theory and research, and have previously been heeded by policymakers in wealthy nations around the world.
That shouldn't be the end of the discussion, though. The share of business-sector economic output going to labor has declined markedly since 2000 (although it's been pretty flat since 2011). Laws and institutions play crucial roles in determining how economic gains are shared. Now that a 21 percent top corporate tax rate is reality in the U.S., it seems like a good time to contemplate how policymakers might go about increasing the likelihood that this actually leads to better outcomes for average American workers. Some options that spring to mind:
- Increase taxes on corporate owners. You wouldn't want to overdo this, given that it would in theory cancel out some of the incentive effects of lowering corporate taxes. But capital gains and dividend taxes target individuals, and thus aren't shunted onto others in the way that corporate taxes inevitably are. They can also be levied progressively so those with higher incomes pay at a higher rate. One argument (there are others) for keeping the tax rates on capital gains and dividends below those for earned income is that such levies amount to double taxation of income already taxed at the corporate level. Now, with the corporate tax rate far below the top individual rate, that should be less of a concern. More broadly, the arguments against heavy corporate income taxation imply that if you are concerned about income inequality or stagnant middle-class living standards, progressive individual income taxation and social spending are better ways to address them.
- Improve the bargaining position of American workers. Only 6.4 percent of private-sector workers in the U.S. belonged to unions in 2016 -- down from 35 percent in the 1950s. Even some conservative thinkers such as the Manhattan Institute's Oren Cass have taken to arguing that this lack of collective representation is harming workers and the economy. I'm not sure exactly what the appropriate policy changes would be here. Cass, for example, argues for not a return to 1950s-style unions but a shift toward less-political, less-confrontational worker organizations that he dubs "co-ops." But acknowledging that the current state of affairs too often leaves workers powerless and voiceless is at least a start.
- Get serious about antitrust enforcement. Lots of recent research has documented the growing economic power of big corporations in the U.S., and speculated on potential negative consequences -- among them reduced corporate investment. A new study (summarized last week by my fellow Bloomberg View columnist Noah Smith) appears to show that this economic concentration is also putting significant downward pressure on wages. Forcing more competition among corporations could thus be good news for workers on multiple fronts.
- Invest in public goods. As described above, corporate capital investments can deliver returns to workers. But so can investments in the kinds of things that corporations generally leave to governments -- transportation infrastructure, education, basic research. A healthy economy needs both.
- Rein in those buybacks. Yes, I just presented the argument that share buybacks by corporations end up flowing into new investment. But what if much of that money could be more productively reinvested by the corporations that earned it, and isn't because "combined with pressure from Wall Street, stock-based incentives make senior executives extremely motivated to do buybacks on a colossal and systemic scale"? This is the argument of economist William Lazonick of the University of Massachusetts at Lowell, and while I'm not sure it's right, subsequent findings on declining private investment by New York University's Germán Gutiérrez and Thomas Philippon seem to back it up. 1 Lazonick calls for a ban on open-market buybacks, which were generally not allowed before the 1980s. Corporations could still pay out cash to shareholders via tender offers and dividends.
This is an idiosyncratic, incomplete list. President Donald Trump has at times seemed to espouse an alternative approach that aims to strengthen the position of workers by cutting down on immigration, restricting trade, and browbeating corporate executives into keeping and creating jobs in the U.S. This comes with big risks, given that immigration and trade deliver net benefits overall to the U.S. economy, and hasn't been pursued by the administration with much coherence or consistency, but is at least something. As for Republicans in Congress, New York Times columnist David Brooks concluded last month after going through his own list of suggestions to improve the lot of American workers that they have "shown astonishingly little interest in these and other ideas, except Senators Marco Rubio, Mike Lee and Tim Scott, Representative Kevin Yoder and a few others."
But that doesn't mean a future congressional majority won't! There's something that Harvard Business School historian David Moss wrote a few years ago that has stuck with me:
Look closely at U.S. history, and you’ll see that deep philosophical differences aren’t new and that some of the most ideologically charged periods produced important policy advances, often delivering the best ideas from both sides. In fact, America’s economic success may be partly attributable to this best-of-both dynamic.
Cutting the corporate tax rate was a free-market conservative "best idea." Now we may need some best ideas generated by other political philosophies to make it pay for workers.
This is the same study I linked to above in reference to the claim that increased market concentration was reducing corporate investment. In the paper, Gutiérrez and Philippon document that investment has been "weak relative to measures of profitability and valuation," especially since about 2000, and attribute this mainly to "decreased competition (due to technology, regulation or common ownership)" and "tightened governance and/or increased short-termism."
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Brooke Sample at firstname.lastname@example.org