The Trump administration has made some highly suspect assertions about its ability to increase wages for American workers. Are we to believe its predictions of $4,000 to $9,000 per person in wage gains due to the recently passed tax cut? On the surface, their assertions seem to have some substance: U.S. wages grew moderately in the fourth quarter of 2017; stock prices remain high since Donald Trump was elected, even after the recent setback; and the president’s favorability ratings rose modestly. But any careful look beyond these measures must lead us to answer, in a word: no.
Last fall, President Trump’s Council of Economic Advisers (CEA), overseen by CEA chairman Kevin Hasset, issued an economic analysis of the proposed corporate tax cut, now passed into law. While the bill cuts personal income taxes, especially for the well-off, the CEA analysis focused on the reduction in the corporate tax rate from 35 percent to 20 percent as the source of substantial wage gains.
Hasset’s CEA notes that business profits have risen strongly in recent decades, while wages have not (though it inexplicably omits the Reagan 1980s, when this trend began). But the report claims that the failures of wages to keep up is the consequence of tax differences with the rest of the world. “The deteriorating relationship between wages of American workers and U.S. corporate profits reflects the state of international tax competition,” he and his team write.
In truth, many factors have suppressed wages. Just to name a few: productivity growth has been slow in recent years; the power of unions has declined and business norms have been notoriously tough on labor; monetary policy has been tight; financial pressure and deregulation have boosted incentives for short-term profits through cost-cutting; and the minimum wage has not been raised to keep up with inflation. While monetary policy has been stimulative, fiscal stimulus has been timid. Yet the CEA, improbably, says it’s all about tax differentials.
The CEA adopts the pre-Keynesian supply-side model of economic growth, reinvigorated by Milton Friedman in the 1970s. The idea, in short, is that more profits and potential returns on investment due to corporate tax cuts will lead to more investment, and more investment to higher productivity and GDP growth—and more demand for workers. So, wages must rise.
The Republican-passed tax cut also includes lower income tax rates. The promise is to create more demand from individuals for goods and services. But this tax cut is so unbalanced in favor of the well-off that more demand will be muted because the rich, rather than spending, tend to save a lot more than the rest. One result will be an enormous federal budget deficit.
To reach a conclusion about wages due to corporate tax cuts, Hasset and his team examine research across countries about how much corporate tax falls on workers versus capital (in short, on owners). On the basis of their investigation of existing studies, the team claims that the result of the Trump/Republican tax cut would, as noted above, be an average $4,000 annual increase in wages for American workers and as high as $9,000. For the median worker in the middle of the pack, it would be $3,000 to $7,000. This would not be a one-time increase, but would continue indefinitely. In sum, they conclude, apparently empirically, that countries with low business taxes pay higher wages, and if America joined the pack of low-tax countries, Americans would virtually automatically get a raise.
The CEA piece was roundly criticized by mainstream economists and even some conservatives. Former Obama treasury secretary Lawrence Summers, now a professor at Harvard, wrote that he would have given any student of his a failing grade if they had handed in such a report. Many others thought the CEA’s claims were seriously overstated.
One major critique is that the studies cited by Hasset and his team were selectively chosen in order to support his case. Other critics say the report oversimplifies the ones it cites. For example, the report does not account for different labor laws, financial regulations, and trade policies when it compares wages levels and changes over time across countries.
Still others note that the evidence cited has been misused. One study the CEA depends on was by Harvard’s Mihir Desai and his colleagues. Based on this study in particular, Hasset and his team make their higher projections of wages up to $,9000 a year. Desai himself, however, says his study was misinterpreted, and that a wage increase of no more than $800 is feasible.
Economist Jennifer Gravelle completed a comprehensive and widely cited analysis for the Congressional Research Service of studies about the incidence of corporate taxes —that is, the degree to which taxes are paid by workers. Overall, she finds it is possible there will be a modest wage increase but it is also entirely possible that the corporate taxes will fall entirely on capital. That is, there could be no wage increase at all.
Most tellingly, and in a truly incomprehensible fashion, the CEA report ignores the United States’ own experience of the last thirty-five years, the years since the deep cuts to individual and corporate taxes under Ronald Reagan and later under George W. Bush. If their initial intention was to claim that wages would rise with tax cuts, why not tell us what happened in our own country? But there was good reason to ignore the American experience. Wages for workers fell or at best stagnated throughout the 1980s and for the most part over the following twenty-five years, with the exception of the Clinton boom of the late 1990s (after, it must be said, a tax hike). Income inequality has risen sharply as well—a trend beginning with Reagan. And business investment was weak under Reagan, while the Trump economists claim that investment will now become stronger as corporate profits rise.
The Reagan track record is misleadingly exalted as a holy grail among tax cut enthusiasts. The growth of the national gross domestic product was rapid under Reagan partly because it was a recovery period after the recession in 1982, giving pro-Reagan economists cover for the bad performance in so many aspects of the economy. It requires repeating: wages did not rise, and fell for many income categories. Further, business investment was weak; and inequality began its inexorable rise. Importantly, productivity grew slowly by historical standards. Reaganomics was a failure on most counts, and also left the nation with a much higher budget deficit than promised.
In what follows, we compare the cut in individual and corporate tax rates against the performance of wages across several demographic groups in America. We show that income exploded at the top of the income distribution compared to the rest of workers. We also illustrate the dubious relationship between business profits and investment, thereby debunking the trickle-down myth that more profits lead virtually automatically to more investment. If demand for goods and services grew rapidly, then a greater impact on business investment than if firms were given a sudden increase in profit would likely be had; but the lopsided tax cuts skewing towards the top in fact limit any potential boost to broad-based demand.
Top Income Tax Rate
First we look at the top income tax rate alongside changes in median earnings. Under Reagan, the top rate was cut from 70 percent to 28 percent between 1982 and 1990 (see Figure 1). Statutory corporate income taxes were cut dramatically in the late 1980s. As shown in Figure 1, median weekly wages for men, adjusted for inflation, stagnated during the decade of Reagan’s tax cuts. One reason they didn’t fall was that men worked more hours, on average, per week—from 41.1 hours in 1981 to 42.6 hours in 1989. Hourly median wages for men fell by nearly a dollar, from $16.90 to $16.00 from 1980 to 1990. Male workers in the bottom tenth of the income distribution experienced a reduction in wages from a meager $8.30 in 1980 to $7.60 per hour in 1990. Perhaps most telling of all, median hourly wages for all workers, male and female, did not rise in the 1980s and were ultimately 0.6 percent lower at the end of the decade.
Bush-era top income tax cuts in the early 2000s did not have a different result. Weekly wages for men fell from $386 in 2001 to $364 in 2006, despite an economic recovery from the minor 2001 recession.
Corporate Tax Cuts in the United States and the United Kingdom
The experience of the United Kingdom also shows that tax cuts do not automatically lead to income increases. Kim Clausing and Ed Kleinbard note that the United Kingdom has a comparable business climate to those of the United States, and therefore provides a better comparison to U.S. outcomes than do the other cross-country analyses undertaken by Hasset. As can be seen in Figure 2, when corporate tax rates were slashed from 30 to 19 percent between 2007 to 2017 in the United Kingdom, wages there fell, the authors point out. Even several years after the Great Recession, they note, “UK [median] wage growth didn’t keep pace with that of the United States,” where tax rates had remained at 35 percent. Inequality began to rise in this period as well.
Inequality in the United States since the 1980s
As for U.S. income inequality, it was essentially launched in the 1980s. Figure 3 shows, according to the Census Bureau, that since the 1980s, individuals in the top fifth of the income distribution now earn almost 30 percent more of America’s total income than they did back then; whereas the middle and bottom 20 percent of earners now each enjoy 20 percent less.
Tax Contributions Internationally across Income Levels
Income taxes have clearly become less progressive in this era. Thomas Piketty and Emmanuel Saez, with colleagues, show in their extensive World Income Report that the top 1 percent and 10 percent contribute less as a proportion of their income to total tax revenue, and the bottom 90 percent contributes more, than did each respective percentile in the 1960s and 1970s.
The core pathway from tax cuts to a higher-wage society, the CEA claims in its report, is through increased investment. However evidence shows that tax cuts in the past few decades have not led to more investment.
“Capital deepening,” or investment in productivity-enhancing capital (machines, software, etc.) associated with a higher capital–labor ratio, which Hasset suggests will follow the tax cuts and lead to productivity and wage gains, simply hasn’t appeared after other corporate tax cuts since Reagan. Higher profits and returns due to tax cuts have not translated into stronger investment. Figure 4 shows that in the years following the Reagan- (early 1980s) and Bush-era (early 2000s) tax cuts, business investment as a percent of GDP declined.
Instead of investing in innovation or hiring more workers, more profits are often channeled into stock buybacks and dividends, to inflate stock value and further enrich firm management and shareholders. As carefully documented by William Lazonick, before the 1980s, stock buybacks were insignificant, whereas now they account for over 50 percent of earnings for all S&P 500 firms, which doesn’t include another 35 percent that goes to dividends. All in all, not much is left for investment in technology, research, or wages.
Finally, a much higher budget deficit may raise interest rates and dampen economic growth, also restraining the possibility of higher wages. If the Republicans wanted the middle- and lower-income workers to benefit, they should have given them a bigger tax cut. Such a tax cut would also have stimulated growth itself more than the one that was passed. Public investment—an alternative stimulus to tax cuts—in infrastructure, education, and anti-poverty programs would have been more desirable.
It should now be clear that the CEA’s conclusions about the current tax regime are significantly misleading. Political energy will now have to be directed to preserving the nation’s safety net, which will be under assault in order to limit a sharp rise in the nation’s budget deficit by the very lawmakers who are creating the outsize deficit.