Congress and the Trump Administration have proposed reducing the corporate tax rate from 35 percent to 20 percent. This week the Council of Economic Advisers released an analysis of the proposal and its potential benefits.
It is sometimes the case when completing analyses of this sort that economic theory does not play out as it should in the real world. However, in the case of corporate tax reform, the evidence indicates that theory has, in the past, and can, in the future, reflect reality.
When it comes to corporate tax rates, economic theory predicts that as taxes are reduced, firms will be encouraged to increase capital investment. Since capital and labor are often complementary, an increase in capital will result in higher productivity of labor and a greater demand for labor. Both increased productivity and increased demand for labor would be beneficial for the U.S. worker, raising wages.
With its corporate tax rate of 35 percent, the United States is less competitive compared to other developed nations. Firms have chosen to move production abroad, reducing demand for U.S. workers. A lower corporate tax rate of 20 percent would encourage production to remain at home, likely increasing demand for labor—and wages.
CEA finds that workers, who have recently seen diminishing growth in their wages over the past decades, could see substantial increases in salary income and wage growth in the future if the corporate tax rate was reduced.
Using studies by Felix (2009) and Desai et al. (2007) and 2016 data on income, CEA approximates that reducing the corporate tax rate to 20 percent would increase average household income by between $4,000 to $9,000, and median household income by between $3,000 and $9,000. CEA anticipates that these benefits would not just be in one year, but would continue until the new rate has been fully absorbed by the economy.
Additionally, the burden of the corporate tax on workers affects their wages. Using past literature, CEA uses a 57 percent burden on labor. Critics of this choice believe that this burden is too high and inaccurate. Past estimates of the burden include 18 percent by the Treasury Department and 25 percent by the Joint Committee on Taxation.
However, in today’s world, capital is much more mobile than labor. Companies can move abroad far more easily than Americans, as can be seen by the wave of inversions over the past five years. The less mobile factor of production—namely labor—carries the burden of the tax.
Using the 57 percent estimate, CEA finds that for every 1 percent increase in the corporate tax rate, workers’ wages decline by 0.3 percent. Lowering the corporate tax rate would lead to an increase in wages.
Finally, CEA analyzes the effect of the reduction on real wage growth. Since 2008, the median real household income has increased by 0.6 percent per year, and the average household income has increased by 1.1 percent per year. Had the corporate tax rate changed in 2008, the comparable growth rates would have been 2.0 percent per year for median real household income and 2.4 percent per year for average household income. These estimates are consistent with rates in OECD countries that have lower corporate tax rates.
Although critics such as Harvard economics professor Lawrence Summers remain skeptical about the CEA study, other experts such as Stanford professor Edward Lazear agree that decreasing the corporate tax rate will benefit both upper- and middle-class workers. By tackling the corporate tax rate, Congress would be helping to increase U.S. growth and bring rates in line with those of other countries. We should all be on board.
Emily Top is a research associate at Economics21.
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