Monday, October 23, 2017

Corporate Profit Tax Cuts and Wages: the UK Experience

Kimberly Clausing and Edward Kleinbard have each written some interesting papers on transfer pricing. Here they team up on a different topic:
The President’s Council of Economic Advisers claims that slashing the corporate tax rate to 20 percent would boost the average American’s wages by $4,000 per year (“very conservatively”) — and perhaps by as much as $9,000. If true, that would be a remarkable gain for working Americans. Unfortunately, it’s extraordinarily unlikely to be true. The two of us can think of dozens of objections to the CEA claim, presented in an official report, but perhaps the place to start is with the United Kingdom, which has already run this experiment. Over the past decade, the United Kingdom has slashed its corporate tax rate, in several steps, from 30 percent down to 19 percent. At the same time, the United States has kept its corporate tax rate constant at 35 percent. Like the United States, Britain has a large open economy, investors in British firms come from all over the world, and Britain provides a sound legal and regulatory environment.
They next document the decline in real median wages in the UK since the UK began its experiment with lower corporate tax rates. They then note:
Of course, the UK example is just one case, but this comparison is a great deal more relevant to the CEA’s claims than the slapdash comparison it presents near the start of its report. The report compares US wage growth over three years to wage growth in 10 unnamed “low-tax” developed economies. But the United States is simply not comparable to small-economy tax havens like Ireland and Switzerland. What’s more, the CEA comparison focuses on average wage growth, while our chart uses median wages.
Their critiques of what the CEA under Kevin Hassett continue. But let’s stick to the idea of using the experiences of other nations who have also reduced corporate profits taxes. KPMG provides corporate profits by nation over the 2003 to 2017 period. Other nations have followed the UK lead. For example, Japan’s rate has been lowered from 42% to less than 31%. One has to ask why didn’t the CEA do comparisons based on nations like Japan and the UK. Update: This CEA report touts Figure 1:
the covariation between the trajectory of inflation-adjusted wages and statutory corporate tax rates (Federal and sub-Federal) between the most-taxed and least-taxed developed countries (OECD) over recent years, visible in Figure 1, is indicative of these papers’ findings. Between 2012 and 2016, the 10 lowest corporate tax countries of the OECD had corporate tax rates 13.9 percentage points lower than the 10 highest corporate tax countries, about the same scale as the reduction currently under consideration in the U.S. The average wage growth in the low tax countries has been dramatically higher
Figure 1 shows the average real wage growth from 2013 to 2016. A lot of these nations have had low corporate tax rates for years so why only show the latest four years? And the term “dramactically” strikes me as hyperbole. One also has to ask what role does transfer pricing abuse play into the measured series? I get what Kimberly Clausing and Edward Kleinbard meant by:
Of course, the UK example is just one case, but this comparison is a great deal more relevant to the CEA’s claims than the slapdash comparison it presents near the start of its report. The report compares US wage growth over three years to wage growth in 10 unnamed “low-tax” developed economies. But the United States is simply not comparable to small-economy tax havens like Ireland and Switzerland.

5 comments:

rosserjb@jmu.edu said...

Comparing with UK is certainly relevant, pgl, probably more so than with any other nation given the similarities in the way our corporate structures are organized and managed.

Don Coffin said...

I would note that an increase in the average (or even the median) earnngs of US workers from what would really be only a moderate cut in corporate income tax liabilities of $4,000 per year is almost literally incredible.

First, the current effective tax rate on corporate income is apparently about 20%, so it's not clear that a cut in the statutory rate will have all that large an effect.

Second, The effect on earnings that Hassett is so confidently predicting is (again, as far as I can tell) something between 2 and 3 the likely magnitude of the reduction in corporate taxes. Which suggests (he says with tongue in cheek) large corporate subsidies should make all corporate employees rich.

Finally, cutting the corporate income tax rates leaves all other employers unaffected. It's really hard to find numbers on this, but as near as I can tell, at most about 50% of workers are employed by corporations subject to the corporate income tax. So to get a $4,000 increase in the average wage of workers would likely require a substantially larger increase in the wages of corporate employees--unless we believe that there's a lot of spillover from corporate to non-corporate wages.

I don't know, frankly, ho any serious economist can take Hassett's conclusions seriously. But because he is chair of the CEA we're going to have to expend time and effort refuting his "findings."

Anonymous said...

the only possible effect of tax cuts it to increase investment

if we are full employment then increased investment will not stimulate the economy or job growth it will just cause excess inflation

therefore the proponents of tax cuts must be certifying that we are at less than full employment*

*(or due to the effects of monopoly power being able to cause runaway inflation, they are certifying that we unemployment level greater than NAIRU)

Anonymous said...

meaning if we are at full employment real wages will not budge

ProGrowthLiberal said...

"the only possible effect of tax cuts it to increase investment".

This is a key point that the Mankiw crew just ignore. Reducing this tax rate does not automatically increase wages or output. There has to be a transmission mechanism, which as you note comes from an alleged increase in investment in new capital. If this effect is small - there is no way we get the results Mankiw and crew suggest.