Geeky Fridays: Effect of Corporate Tax Cuts


Nothing hammers readership here at Wickersham’s Conscience like writing about economics. The dismal science is just not a popular topic. But it is important, and we are finding out how important as we live with the fallout from the Tax Cuts and Jobs Act (TCJA) of 2017. 

Harvard has published an interesting study of the effect of corporate tax cuts on employment and wages.[^1] Remember, the Republicans’ rationale for TJCA was that it would create hundreds of thousands of new jobs and increase wages as corporations took all those tax savings and grew their businesses. The authors used state corporate tax rates as the model.

Why state corporate tax rates and not federal corporate tax rats?

First, unlike federal tax rate changes, which are rare and affect all firms, state-level corporate rate changes are more frequent. Second, state-level corporate tax changes affect only a subset of states, which leaves unaffected states as potential controls that can be used to estimate causal effects of tax changes. Third, there is significant cross-sectional variation in state-level corporate tax changes during our sample period.

Their findings:

We show that tax cut states had similar trends in income inequality to states without tax cuts. 

We find that corporate tax cuts increase income inequality over a three-year period. Focusing on the share of income accruing to the top 1%, we find that a 1 percentage point (pp.) cut in corporate taxes increases this share by 1.5pp.

If there were more jobs, or better pay for the common worker, income inequality would contract. Instead, corporate tax cuts just make the rich richer and do nothing at all to increase pay, increase jobs or reduce income inequality. The economists controlled for other factors that might have impacted income inequality. Without trying to explain regression analysis here, let’s just say the evidence is compelling. It’s not a surprise; no one thinks trickle down works. But now it’s even clearer that it doesn’t.

There seem to be two things happening. First, in higher income brackets, bonuses and raises are often tied to increased profitability. Reduced state corporate tax rates means more net profit. It’s pretty rare for lower-level employees to have their salary tied to increases in corporate profitability. Second, persons in higher income brackets shift their effort into capital and out of labor, because the capital investment is taxed at a lower rate than labor. So, yes, the system really is loaded against workers in the lower-income brackets.

The authors make another interesting point:

Note, however, that the benefits to existing owners are front-loaded, while the benefits to workers are back-loaded and only materialize after competitive forces drive down after-tax profits. This clarifies that attempts to use corporate tax cuts as a means to boost the local economy depend on increases in top income inequality to generate additional economic activity. In contrast, other approaches such as government spending at the local level (e.g., Su ́arez Serrato and Wingender (2011)) or tax cuts to low-income earners (e.g., Zidar (2015)) may stimulate the economy without increasing inequality.

It’s pretty easy to summarize all this: more proof trickle down doesn’t. If you want to reduce inequality, the authors say, increase government spending at the local level, or reduce taxes on lower-income earners. Since state governments cannot run a deficit, that requires higher taxes on upper-income earners. Good luck with that.

 

[^1]: Suresh Nallareddy, Ethan Rouen and Juan Carlos Suàrez Serrato, “Corporate Tax Cuts Increase Income Inequality,” Harvard Working Paper 18-101.

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One thought on “Geeky Fridays: Effect of Corporate Tax Cuts

  1. The trickle down gambit has been use by various oligarchical groups for centuries and guess what … it did not work. Back in high school, a long long time ago we learned some simple economic repeating patterns from history. If one studies the Roman Empire of other similar “political entities” you see that they thrived in general or in a specific province/region at the time the tax yoke was lessened on the local producers and they ran into lack of production, rebellion and decline when the tax yoke was increased to send more to the ruling oligarchy. As Solomon said there is nothing new under the sun.

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