Economics 101: Reducing Corporate Income Tax Rates, Productivity, Higher Wages and More

By at 20 October, 2017, 9:00 am

Small Business Insider

by Raymond J. Keating-

It’s kind of amusing to witness the contortions that left-wing economists go through to essentially ignore basic economics when arguing for, what amounts to, their politically-driven and desired outcomes. The latest example has to do with opposition to reducing the federal corporate income tax rate from 35 percent to 20 percent, as proposed in the “Big 6” tax framework.

In the discussion, supporters of this tax cut have argued, among other points, that a substantially lower tax rate would be a plus for wage growth. Many economists on the left will have none of it. For example, Paul Krugman, in his New York Times column, was completely dismissive, and to support his position, in a not-exactly-coherent manner, he seems to assume that markets are not all that competitive, uses terms like “monopoly rents” and “market power,” and downplays capital mobility. Krugman also is caught up in the argument of where the burden of the corporate income tax falls, that is, the degree that it falls on shareholders or on the wages of the firm’s employees.

The objections and assertions by Krugman and others on the issue of the corporate income tax and its effect of wages are addressed and refuted in the report from the Council of Economic Advisers, and its chairman, Kevin Hassett. As noted in the paper:

“This sizable empirical literature measures the relationship between wages and corporate taxes, controlling for other variables that may affect wage growth across countries and over time. The literature suggests the relationship between corporate taxes and wages is more than observational and is econometrically robust.”

But let’s be clear, the key points regarding a substantial reduction in the corporate tax rate are its effect on incentives, decision-making, resource allocation, improved competitiveness, and economic growth.

First, reducing the corporate tax rate incentivizes business investment and growth.

If you want more business investment and development, and along with that increased employment, then enhancing the returns on such activity via a lower tax rate makes sense. It’s straightforward economics.

Second, enhanced investment boosts productivity, which generates increased profits and higher earnings for workers.

It must be kept in mind that the fundamental driving factor behind higher earnings for workers is the increased productivity of those workers. In simplest terms, the more productive and valuable the work, the higher the compensation for such work. American workers are among the world’s highest paid because they are among the most productive. This critical point is noted in the CEA report:

“An extensive literature on corporate tax policy documents that reducing the corporate tax rate results in increased capital formation and economic output. Effectively, reductions in the corporate tax rate incentivize corporations to pursue additional capital investments as their cost declines. Complementarities between labor and capital then imply that the demand for labor rises under capital deepening and labor becomes more productive.

“Standard economic theory implies that the result of more productive and more sought-after labor is an increase in the price of labor, or worker wages. Indeed, considerable academic research indicates that this is the case; to summarize, the literature finds that worker wages are lower when corporate taxes are higher. Capital deepening, which brings additional returns to the owners of capital, brings returns to workers as well.”

Third, a critical point most certainly avoided by those opposing such tax cuts is the issue of efficient resource allocation.

Are consumers, workers, entrepreneurs, businesses and investors better off if resources are left in the private sector, in the hands of the workers, entrepreneurs, businesses and investors who earned them, or if resources are transferred to politicians and government?

Again, Economics 101 explains that the private sector and government operate under very different incentives. Private enterprises are guided and disciplined by prices, competition, profits and losses, with consumers ultimately deciding value, success and failure. However, the public sector is guided by political incentives, with special interests, politicians seeking re-election, and bureaucrats looking to increase budgets and staff calling the shots, with failure often rewarded with more money and staff.

Understanding these different sets of incentives, then it becomes clear that the economy will benefit from leaving resources in the private sector. And that is the case even if a lower corporate tax rate merely means increased dividends for shareholders, rather than increased investment by a company. Again, expanded returns to the owners of a company means those owners will then use those dollars for other investments, for savings (and thereby lent out to other individuals or businesses), or for consumption (again, thereby supporting entrepreneurs, businesses and workers creating value).

Fourth, as noted in a recent SBE Council analysis, the United States imposes the second highest corporate income tax rate on the planet (among 171 nations).

Given the increasing mobility of capital (something even acknowledged by Krugman, though he downplays it by saying that “capital mobility remains far from perfect” – who said this, or anything else is perfect?), markedly reducing the U.S. corporate income tax enhances incentives for businesses to set up shop and invest in the U.S. Again, that’s a positive for workers’ wages.

It must also be noted that these noncompetitive rates impact small businesses, both as suppliers and as business entities themselves.  Regarding C-corps, 86 percent have less than 20 employees and 96.9 percent have less than 100 employees.  These businesses, like all U.S. business, are competing in a global marketplace.

Finally, all of these effects – incentivizing business growth and investment, boosting productivity, creating a more beneficial allocation of resources, and improving international competitiveness – mean that a lower corporate income tax rate, especially a substantial reduction from 35 percent to 20 percent, will improve economic, income and employment growth.

The only way to deny that is to deny basic, common sense economics.


Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.

Keating’s latest book published by SBE Council is titled Unleashing Small Business Through IP:  The Role of Intellectual Property in Driving Entrepreneurship, Innovation and Investment and it is available free on SBE Council’s website here.


News and Media Releases