Federal tax cuts won’t boost workers’ wages — here’s why

Recent reports paint a picture of tepid U.S. wage growth, with wages rising just 0.2 percent after inflation in the first quarter of 2018. It wasn’t supposed to be that way.  In selling the recentfederal tax overhaul, sponsors claimed that cutting corporate taxes would boost wages for workers. Yet the failure of corporate tax cuts to boost workers’ wages should not be a surprise, our research suggests.

In a new paper with Suresh Nallareddy of Duke University we examine changes to state corporate tax rates. We find that when states cut corporate tax rates, most workers’ wages do not rise. Instead, income inequality increases, with most of the benefits of the cuts going to the ultra-wealthy.

{mosads}Inequality has seen meteoric increases in the United States. Across the country, the share of income going to the top 1 percent of earners rose from 14.5 to 19.8 percent on average between 1990 and 2010. Our research shows that corporate tax cuts were responsible for as much as 12.5 percent of that growth in inequality.

From 1990 to 2010, 25 states reduced their corporate tax rates at least once. These tax cuts meant more money for business owners, who could either pocket the money or invest it in plants and equipment, hiring more workers, or giving employees raises.

In states that cut corporate tax rates, private investment increased by as much as 16 percent in subsequent years, providing some credence to claims that putting more money in business owners’ hands stimulates economic growth. 

Those investments are not yielding higher wages for the average worker, though. Using data from the Internal Revenue Service, we find that after states cut corporate tax rates, income increased for those making more than $200,000 a year. For everyone else, wages and incomes in those states remained flat. 

Our analysis also reveals another troubling trend: After corporate tax cuts, income rose for the wealthy, but not because their salaries increased – those salaries actually fell by an average of 3.5 percent. Instead, wealthy individuals reported an 11 percent increase in income tied to investment and capital. Investment and capital income are precisely the sorts of income that many states now tax at lower corporate rates.

This result suggests that after states slash corporate tax rates, some wealthy individuals are reclassifying their earnings as business income in order to take advantage of lower tax rates. Such income shifting by the rich isn’t illegal in many, perhaps even most, cases. But this sort of gamesmanship is certainly not what voters picture when they clamor for tax relief or a fairer taxsystem.

The state-level trends we found do not bode well for the new federal tax cuts. Instead, the evidence strongly suggests those cuts will increase income inequality. And Congress may make the problem even worse. 

Congress has yet to decide how to make up for the lost tax revenue. If it pays for tax cuts with cuts to government spending, that would further hurt the average worker, since research shows public spending cuts disproportionately harm low wage workers. 

On a recent trip to West Virginia, President Trump tossed out his prepared remarks praising the new tax law to instead make spurious statements criticizing immigrants. Perhaps changing the subject away from taxes was no accident.

West Virginia’s experiments with corporate tax cuts have failed the average worker. In the year after the state cut its corporate tax rate, the top 1 percent of saw their incomes grow. Meanwhile, the state’s unemployment rate increased by 33 percent in the same year.

Similarly, after Kansas cut its corporate taxes in 2003, the share of income going to the richest residents increased by 32 percent. 

Republicans initially touted the tax cuts as a policy win that would help them going into the midterm elections. Sadly, our research confirms what voters in many states already know: Income inequality is likely to rise as the reality of the recent tax cuts materializes. No wonder proponents of the federal tax cuts  have been largely silent about this so-called legislative win. 

Juan Carlos Suarez-Serrato is an assistant professor of economics at Duke University. Ethan Rouen is an assistant professor of business administration at Harvard Business School.