Some Immediate Benefits of the Corporate Tax Cut

Copyright, TheHill.com

By cutting the statutory corporate tax rate and by permitting investment expenses to be immediately deducted from corporate income, the new tax law encourages corporations to enhance their workers' productivity by investing in structures, equipment and software.

The additional investment will accumulate over several years, which means that the full effect on productivity and wages will not be felt for several years.

However, Economics Nobel Laureate Paul Krugman further asserts that there are essentially no benefits for workers in 2018, despite the fact that a number of corporations have announced bonuses for workers while saying that the bonuses derive from the new tax law.

The simplest model of investment and worker productivity agrees that aggregate wage increases would not be discernible in the first year following a permanent and unanticipated capital income tax cut because of the time that it takes for investment to be planned, executed and translated in to greater worker productivity.

But Krugman, Obama economic adviser Larry Summers, and I, among others, agree that our economy and this tax cut have some meaningful differences from the simple model. One of those differences is that President Trump's signature last week was not an entire surprise.

The U.S. had been behind most of the world in cutting its corporate rate, and it was largely a matter of time until the U.S. did the same, especially in 2016 when Republicans won the White House and both houses of Congress.

Throughout 2017, businesses were making plans understanding the very real possibility that federal corporate tax rates would be lower, and the execution of those plans are already adding a bit to worker productivity.

The simple model also ignores that a lot of businesses are not organized or taxed as U.S.-based C-corporations, which are the types of corporations that have been subject to high statutory rates by worldwide standards.

This has resulted in too little business activity occurring with the legal and organizational advantages of the C-corporation, and productivity has suffered as a result of companies' keeping activities away from the high C-corp rates.

Reallocating activity to U.S.-based C-corporations can happen more quickly than the building of new structures or manufacturing new equipment does. This means that part of the productivity effect can occur quickly too.

The simple model also treats labor costs as variable, which is a reasonable treatment for multi-year time frames. But over a period of a few weeks or months, which is the time frame discussed by Professor Krugman, much of the labor costs are slow to adjust, due primarily to the fact that it takes time to attract and sign good employees.

With businesses anticipating productivity growth over the next several years, it makes sense for them to take some immediate steps to solidify their workforce. (It's odd that Krugman missed this effect: he frequently writes about the "JOLTS" labor data, the entire point of which is that labor costs adjust slowly from the perspective of weekly or monthly data).

I agree with Professor Krugman that actions speak louder than words in matters of economics. Although they sometimes agree, often businesses say one thing and do another. This is especially true when the federal government uses its regulatory might to encourage businesses to say the "right thing," as it did when it rolled out the Affordable Care Act a few years ago.

But it is inaccurate to claim that workers must wait before seeing any benefits of the corporate tax cut.

At 21% or 20%, new corporate tax rate will boost US economy

Copyright, TheHill.com

Since the 1990s, U.S. corporations have been subject to one of the highest statutory tax rates in the world. The high rate has caused them to rearrange their affairs to avoid investing, especially in lines of business subject to the full rate, and thereby reducing productivity and workers’ wages.

But now Republicans in Congress appear to have agreed on reducing the rate by 14 points, to 21 percent, plus the applicable state rate, bringing the total into line with the statutory rates elsewhere in the industrialized world.

President Trump had originally insisted on a federal corporate rate of no more than 20 percent, but Congress appears to have chosen 21 in order enhance the bill’s revenue outlook. It is worth assessing how much revenue was gained, and worker wages lost, by this deviation from the president’s plan.

Although I expect that the federal government will be getting less corporate tax revenue than it would without any tax reform, it is possible that the change from 20 to 21 percent by itself has little or no effect on revenue.

That one extra point may prevent the U.S. from undercutting a number of countries such as Spain, the Netherlands, Austria and Chile and thereby reduce the amount of business activity that relocates here from those nations.

So, as compared to the president’s plan, the IRS will be collecting an extra point on corporate income, but there will be less corporate income than there would have been.

The tax reform’s expensing provisions — generous deductions for new investment projects — also encourage business investment apart from the rate cut, and it has been argued that expensing provisions by themselves create a lot of the economic growth generated by the reform.

Thus, even if adding a point does little to enhance revenue, it may also do little to limit the wage gains that come with reforming corporate taxes.

It is important to remember that much business is not corporate business, but rather organized as partnerships, S-corporations, etc. Ideally these organizational decisions would be made for real business, rather than tax reasons.

It remains to be seen how the new corporate rate meshes with the reform of taxation of non-corporate businesses, because it depends on how the IRS and tax accountants interpret the new rules.

But I expect that there are some non-corporate businesses whose rates would have been a couple of points higher than a 20-percent corporate rate (plus the relevant personal income and state corporate taxation), so that adding a point to the corporate rate mitigates some of the unintended consequences on that margin.

Finally, future Congresses may be willing to further change the rates, especially to the degree that the changes are small. Recall that the last big corporate rate cut in 1986 was followed by a one-point change during the Clinton administration.

For all of these reasons, the consequences of a one-point deviation from the president’s plan are small compared to the overall economic benefits from a long-overdue reform of the corporate tax.