Economics
Correlation between Wages and Taxation

Wonkblog Analysis / Be skeptical of Trump’s claim that wages will soar after he cuts taxes

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Peter Burgess

Wonkblog Analysis Be skeptical of Trump’s claim that wages will soar after he cuts taxes

Play Video 1:24 Trump lays out goals for tax plan

President Trump spoke about his coming announcement on taxes at the White House on Sept. 26, with a group of bipartisan lawmakers from the House Ways and Means Committee. (The Washington Post) America's middle class is hungry for a raise after years of stagnant pay. President Trump keeps saying that he can make bigger paychecks happen.

Trump argues that wages will jump after he cuts business tax rates. He's been saying that for months. His plan will “lower tax rates for business to create more jobs and higher wages for Americans,” Trump told a group of lawmakers Tuesday as he tried to win support for his plan to make the corporate tax rate 20 percent, a major cut from the current 35 percent level.

Other Republican lawmakers have picked up the talking point.

“If we lower the tax rates, these kinds of (American) companies will prosper, will grow, will hire, they’ll increase wages,” House Speaker Paul D. Ryan (R-Wis.) said Tuesday, echoing Trump. “There’s no doubt about it, this country needs this.”

So is the claim true? Do wages always rise when corporate tax rates go down?

Well, it didn't happen after the 1986 Tax Reform Act. Wages fell in the months and years after President Ronald Reagan signed the bipartisan legislation in October 1986, which slashed the corporate tax rate from 46 to 34 percent.

[Republicans to unveil broad tax cuts, put off tough decisions]

Average weekly wages for rank-and-file workers (non-supervisors) went from $285 a week in the autumn of 1986 to $282 a week in October 1987, according to Labor Department statistics that are adjusted for inflation. And they kept dropping. Average weekly wages hit $271 a week by 1990.



There aren't any other time frames to check because the United States hasn't done any big overhauls to corporate tax rates since 1986.

But other countries have. Economic scholars have studied what happened elsewhere to try to figure out if tax cuts spur higher wages. Their conclusions are all over the place.

“There's just not any evidence that there's a huge effect on wages or economic growth” if you cut business taxes, says Len Burman, co-founder of the Tax Policy Center, a think tank, and a former Treasury official under President Bill Clinton. “It's irresponsible to overhype the claims.”

Burman has found the vast majority of the benefits of a corporate tax cut will go to the wealthy. But many right-leaning scholars say the opposite.

“There are absolutely middle-class wage impacts,” says Aparna Mathur, an economist at the right-leaning American Enterprise Institute. “I do think rate cuts would benefit worker wages.”

Mathur co-wrote a study with Kevin Hassett, who is now the head of Trump's Council of Economic Advisers, that found substantial impacts of corporate tax changes on wages. Every dollar of higher taxes leads to a reduction of $2 or more in wages, they calculated.

One of the foremost experts on this subject is Alan Auerbach, a professor of economics and law at the University of California at Berkeley. He says business tax cuts can increase wages “under some circumstances.” Simply cutting the rates isn't enough.

Trump and Congress have to get the tax recipe right if they really want to have a good chance at boosting middle-class wages. Auerbach says there are two things lawmakers should do.

First, they need to ensure the 2017 (or 2018) tax bill doesn't add to America's $20 trillion debt.

Second, they need to find ways to incentivize business investment.

What we know so far of Trump's tax plan is that it checks the box for investment incentives. It has provisions such as allowing companies to deduct the costs of building a new factory right away.

But the plan is also likely to add $1.5 trillion to the debt. That's harmful on a lot of levels. It encourages investment money to go to finance the government debt instead of private companies, and it means the United States will probably have to raise taxes down the road.

The 1986 legislation actually had the reverse problem. It was deficit neutral, so it didn't add to the debt. But it didn't have good incentives for investment. To fully pay for the corporate and individual tax cuts, the 1986 bill “broadened the base,” meaning it cut a lot of loopholes and tax breaks companies used to use to lower their tax bills.

“It's probably best to think of the 1986 reform as increasing taxes on businesses,” Auerbach says.

Economists across the political spectrum are largely in agreement that wages rise when companies invest more money on new factories, more research and better technology. That makes workers more productive, which makes them more valuable. Companies are willing to pay more for valuable employees.

Since the Great Recession, business investment has been anemic, which is one of the reasons experts think wage growth has been so lousy in this recovery. It could be a game changer if this tax package spurs more investment, but it's not a guarantee.

Real tax reform is hard. That's why it doesn't happen often. There will be winners and losers. In order for American workers to be the winners, Congress and the president have to make tough calls that balance offering tax breaks for business investment with finding ways to raise revenue elsewhere so the plan doesn't add to the debt.

“The real challenge is you have to do tax reform right,” Mathur says.
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Heather Long is an economics correspondent. Prior to joining Wonkblog, she was a senior economics reporter at CNN and a columnist and deputy editor at The Patriot-News in Harrisburg, Pennsylvania. Follow @byHeatherLong