Propaganda all wrong: Lower tax rates will help economy and workers

Raymond Keating
Raymond Keating

Politics drives the war against tax relief and reform for U.S. businesses, certainly not sound economic thinking. The political battle over big changes to our tax code has been engaged for months. With Republicans in both the U.S. House and Senate each laying out their versions of the Tax Cuts and Jobs Act, the intensity of battle has ramped up significantly.

Unfortunately, in a political war economic common sense becomes the first casualty. Specifically, the political left has stepped up its propaganda asserting lower income tax rates for businesses won’t benefit economic growth and worker compensation.

Such political propaganda actually is countered rather neatly in two recent papers from the Council of Economic Advisers now led by economist Kevin Hassett. The first report looked at evidence regarding corporate income taxation and its effects on wages. The second report examined the evidence on the effects of tax changes on capital formation and economic growth.

Each paper provides an extensive review of the economic literature on the subjects, makes clear properly structured business tax relief is good news for economic growth and worker compensation and provides estimates on how key tax measures in the mix — namely, reducing the top corporate income tax rate from 35 percent to 20 percent and allowing for full expensing of
non-structures capital spending — would affect growth and wages.

The economics are actually straightforward. A substantively lower tax rate and allowing expensing of capital spending (that is, fully writing off capital expenditures in the year made) enhance incentives for investment and business expansion. Those incentives work domestically as well as across borders given the international mobility of capital. Workers benefit as increased investments in new technologies, equipment, machinery, software, and so on boost labor productivity, given that such productivity is largely what drives compensation.

It also follows that increased private business investment plays a central role in economic growth, both now and in the future. In addition, faster investment and economic growth are accompanied by an increased demand for labor, which further boosts worker pay.

Well, imagine that: a win-win. Contrary to the political fiction peddled since the days of Karl Marx, owners and workers are not at odds, but need each other to prosper.

As explained in the first 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.”

In the second study, the CEA estimated that corporate tax reform alone would increase gross domestic product between 3 percent and 5 percent over the baseline long-run projection with such benefits accruing in as soon as three to five years, or in double that time. Also, the average household would, conservatively, realize an increase in wage and salary income of $4,000.

The key points are clear: The results of reducing the corporate income tax rate and implementing full expensing for
non-structure capital expenditures are positives for the economy. But there’s more. The CEA also pointed out:

“There will be additional GDP effects from reforms to individual income and pass-through business taxes, which we have not modeled, as well as growth from regulatory reform.” In fact, given the vastly expanded and growing role of
non-C-Corp businesses, such as S Corps and LLCs, in our economy, the magnitude of tax rate reductions and expanded business expensing could be far more substantial than the CEA estimates.

The CEA hit on a critical point in its second report on corporate tax reform:

“Workers have not seen real wage increases because firms have been discouraged from investing in America by outdated tax policy and heavy regulation.” Indeed, disincentives for economic risk-taking due to burdensome tax and regulatory policies have resulted in a grossly under-performing economy for more than a decade now. Reform and relief are desperately needed.

Political propaganda often is a tool used during wartime. But there should be no war or battle over working to accelerate investment in the U.S., and therefore, cranking up economic and wage growth. If it was all about the economics, pro-growth tax policy would be a peaceful, bipartisan affair.