“You all just got a lot richer,” Trump reportedly told guests at Mar-a-Lago. But Republicans will nonetheless keep insisting that the corporate tax cut that is the main item in the tax bill is really for the benefit of workers. They will be aided in this claim by some recent corporate announcements of bonuses or wage hikes that they attribute to the tax cut.
It’s nonsense, of course. Think of the motivation: lots of companies are raising wages at least a bit in the face of tight labor markets; pretending that it’s because of the tax cut is a cheap way to curry favor with an administration that has no hesitation about using regulatory and antitrust decisions to reward friends and punish enemies. It’s basically Carrier all over: make a Trump-friendly splash by declaring that he persuaded you to save jobs, then lay off lots of workers after the cameras have moved on.
But there’s a larger point here: even if you believe economic analyses that suggest corporate tax cuts are good for wages, it shouldn’t happen right away. Any trickle-down should come about because the tax cuts lead to higher investment, which leads over time to a larger capital stock – and it’s the increase in the capital stock, which may take many years, that leads to the wage rise.
I keep finding it helpful to use a diagram representing the economy corporate tax-cutters imagine we have: a one-sector economy with no monopoly power, open to inflows of foreign capital. (Adding the reality of monopoly rents, noncorporate capital, and nontraded goods all reduce the extent of trickle-down.) This stylized economy looks like Figure 1:
The downward-sloping line is the marginal product of capital, which is equal (in this model) to the pre-tax rate of return r. The after-tax return is r(1-t), where t is the tax rate.
Given an initial capital stock K, GDP is the integral of the area under the r curve up to K. Of this, rK goes to pre-tax profits, of which the government takes a share t and the rest goes to after-tax profits. What’s left, the triangle at the top, is wages.
Now suppose the corporate tax rate is cut to a lower level t’. This raises the after-tax rate of return for any given capital stock. The country faces a long-run supply curve for capital; this curve would be horizontal for a small open economy, is surely upward-sloping for the United States. Still, over time the capital stock rises to K’. This in turn leads to higher wages:
The crucial words, however, are “over time.” For a variety of reasons it would take a number of years for the capital stock to rise to its long-run level. And in the short run we wouldn’t expect wages to rise at all. Certainly not in the first week after the tax cut!
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So if you suspect that these corporate announcements are political theater, not real economic events, the very models tax-cut enthusiasts like to cite back you up. There will be negligible wage effects of the tax cut in 2018; for the first few years, it’s basically all Mar-a-Lago.
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