Don’t Ignore the Long Run When Evaluating Corporate Tax Cuts

Do corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cuts boost workers’ wages? The answer depends on your time frame.

A new research paper from economists at the Joint Committee on Taxation (JCT) and Federal Reserve Board looked at how the 2017 Tax Cuts and Jobs Act (TCJA) corporate provisions affected wages from 2018 through 2019. In contrast to the Trump administration’s predictions at the time, the study found that most workers did not see any earnings changes in the two years immediately following the tax cuts, although the general economic trends over this period were positive.

While the paper provides useful insights into the short-run effects of corporate tax cuts, it does not examine the long-run effects—and most research shows that in the long run, corporate tax cuts can benefit all workers, not just workers at the top of the income distribution.

To start, it is useful to unpack how corporate tax cuts affect returns to capital investment. A cut specifically in the corporate tax rate (the focus of this study) increases the marginal rate of return on new investment, generating higher profits for the firm for each dollar invested going forward. However, a corporate tax rate cut also increases profits for old capital investment. That is, the immediate effect of a corporate tax rate cut is that firms receive a windfall for investments already undertaken.

We would not expect the windfall component of the corporate rate reduction to lead to higher wages but rather an increase in profits and shareholder returns in the short run. However, we would expect the lower corporate tax rate to incentivize new investment, leading to greater demand for labor, more employment, higher productivity, and higher wages over the long run, which takes several years to unfold. This is in fact what we assume in our Taxes and Growth model: in the first year of a corporate tax cut, we estimate 90 percent of the burden of the corporate tax falls on the owner’s capital and 80 percent in the second year, implying it is owners who receive the lion’s share of a corporate rate cut in the short run.

This is a fairly standard approach to modeling the effects of a corporate rate reduction, with similar assumptions used by the Joint Committee on Taxation and others. The study for the most part corroborates the standard view, measuring specifically who benefits in the short run and to what degree. The study finds that in the two years following the corporate tax rate cut, nearly half of the gains accrued to firm owners in the form of stock buybacks or dividend payouts, with the rest accruing to executives and other highly-paid workers. When considering how many workers are themselves owners holding shares in their firms, the authors find about 80 percent of the gains accrued to the top 10 percent of earners in the short run.

However, the study also finds the corporate rate reduction led to substantial increases in employment and investment in the first two years, consistent with other studies.

The authors do not estimate longer-run effects beyond year two, stating: “…the results [do not] capture a range of potentially important channels through which corporate tax cuts may affect welfare. For example, in the long run, higher investment may increase productivity, lower consumer prices, and broadly increase workers’ real wages.” The study’s evidence of a large increase in investment in the first two years bolsters the standard expectation that the corporate rate reduction will lead to substantial wage gains over time. In our model, we assume that by year five, half of the benefits of a corporate rate reduction accrue to workers, consistent with research on who bears the burden of the corporate tax, and our assumption is actually on the lower end of such estimates.

Moreover, the authors’ methodology of comparing C corps to S corps, the latter of which are taxed as pass-throughs and thus not subject to the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , does not allow them to examine the effects of other tax provisions of TCJA, such as bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , on workers at corporate firms. Since both corporations and pass-throughs can take bonus depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. , the study cannot isolate the effects of this policy on corporations specifically. For example, a growing literature shows bonus depreciation increases investment and employment for affected firms, which has the potential to increase long-run wages.

However, as the authors note, many of the provisions benefiting both corporations and pass-through entities were scheduled to expire, unlike the corporate rate cut which was made permanent. If businesses expect the provisions to expire, and that informs their investment decisions today, it is possible that even a better methodology that also looks at more than two years of data would still find muted effects on long-run wages. In general, the evidence shows that past episodes of temporary bonus depreciation boosted investment and employment while having mixed effects on wages.

Nonetheless, the paper adds to our understanding of how corporate income taxes affect the short-run behavior of firms. But we should not ignore other research showing that the benefits of a corporate tax cut take time to fully phase in and that workers benefit when looking at a longer time horizon.

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