The corporate tax cut will never trickle down

The immediate benefits of the corporate tax cut have gone to stockholders and executives rather than workers. The long-term benefits will too.


Dropping the corporate tax rate from 35% to 21% was the centerpiece of the tax reform package Republicans passed (with no Democratic votes) and Trump signed late last year. They sold that cut with the argument that lower corporate taxes would stimulate investment: Rather than build that new factory in Indonesia or Vietnam, a corporation might site it in Iowa instead, creating new jobs and raising wages. So while it might look like the benefits would go entirely to wealthy shareholders, in the long run that money would flow to American workers. American households, Trump economic advisors claimed, would see their incomes go up by $4000 a year over the next 3-5 years.

For a few weeks, it looked like the trickle-down was happening: A number of companies responded to the tax cut by giving their workers a one-time $1000 bonus — small potatoes compared to what the companies themselves were set to rake in, but not bad if it represented a down payment on future wage increases.

But how long would it take those increases to show up? Well, not immediately, in spite of the well-publicized bonuses. And not in one quarter. CBS reported in April that the corporate windfall (financed by increasing the federal budget deficit) was mostly going into stock manipulations.

In the first quarter, corporate America committed $305 billion to cash takeovers and stock buybacks, more than double the $131 billion in pre-tax wage growth for both new and existing workers subject to income tax withholding, TrimTabs calculates.

Worse, the Bureau of Labor Statistics is reporting bad news for “production and nonsupervisory employees”.

From May 2017 to May 2018, real average hourly earnings decreased 0.1 percent

The Washington Post elaborates, saying that this category “accounts for about four-fifths of the privately employed workers in America”. It also provides this graph.

How long? But it terms of the tax cut, it’s still early days. Of course the process of building new factories and hiring new workers would take longer than just a few months. So when should we expect the corporate tax cut to trickle down? Two years? Five years? Ten?

What about never?In his Friday column, Paul Krugman explains why the tax-motivated new factories and jobs and higher wages aren’t coming, not immediately and probably not ever. He labels his argument as “wonkish”, meaning that ordinary people who aren’t economists may find it hard to follow. So let me interpret a little.

The vision of low corporate taxes creating new jobs with higher wages comes from the Industrial Era, the age of coal-powered textile mills and Henry Ford’s assembly lines. Business investment in those days was mostly big, heavy equipment that cost a lot of money and was meant to last for decades or even longer. (I live in an apartment in a converted textile mill. The mill was built in the 1820s.) Businesses were national (or more likely, local) in those days, so a company located in Akron or Dearborn paid taxes in Akron or Dearborn.

That’s not what the economy looks like any more.

Tax havens. The biggest corporations are multi-national, and they book their profits in whatever countries their accountants choose. One trick is to transfer a company’s intellectual property to a foreign subsidiary, and then pay massive royalties and licensing fees to that subsidiary.

The rights to Nike’s Swoosh trademark, Uber’s taxi-hailing app, Allergan’s Botox patents and Facebook’s social media technology have all resided in shell companies that listed as their headquarters Appleby offices in Bermuda and Grand Cayman, the records show.

When pieces of your product — an iPhone, say — are made all over the world, who’s to say what country the profit is made in? Your accountants say. And they all say the same things: You made your profits in a tax haven.

Indeed, a tiny handful of jurisdictions — mostly Bermuda, Ireland, Luxembourg and the Netherlands — now account for 63 percent of all profits that American multinational companies claim to earn overseas, according to an analysis by Gabriel Zucman, an assistant professor of economics at the University of California, Berkeley.

Think about it: When was the last time you bought something marked “Made in Luxembourg”? Multinationals don’t build factories and employ workers in low-tax countries, they just route their profits there.

Krugman looks at the profit-to-wage ratio of foreign firms and local firms in a variety of countries.

If places like Puerto Rico and Ireland were just massively more productive than the US or Germany — producing enormous profits with relatively low labor costs — that would apply to their local firms too. But it doesn’t. For local firms, the ratio of profits to wages stays pretty constant across the board. It’s only foreign firms that have managed to unlock the Irish productivity miracle — not with actual production that employs workers, but via accounting tricks that claim profits produced by workers in other countries.

In short, multinational corporations have benefited enormously from Ireland’s generous tax laws. Irish workers, not so much. And with time, the corporations get better and better at gaming the tax system.

So lower US corporate taxes may induce corporations to book more of their profits here, for what that’s worth. But that’s an accounting gimmick, not an actual change in economic activity.

But even with that illusion making the effect look bigger than it is, won’t lower taxes still motivate investment and create jobs? Why doesn’t that work? This is where Krugman gets wonkish.

What investment means now. In the Industrial Era, nothing was more solid than a factory. Henry Ford started building his massive River Rouge complex in Dearborn during World War I, and it’s still there. Once it made Model T’s; now it makes F-150 trucks. The US Steel complex in Gary is even older, going back to 1908. Firestone in Akron, Caterpillar in Peoria — the big Industrial Era companies were virtually synonymous with the towns where their factories were.

In the Industrial Era, corporate investment was long-haul investment. You bought land and erected massive buildings to house huge machines. You dug canals and built railroad spurs that came right up to the beginnings and ends of your production lines. The industrialists who made those investments were looking half a century into the future, or even longer.

But most corporate investment these days is far more ephemeral. Take Google, the second-most valuable company in the world. What does it make exactly? Where is its River Rouge or Gary Works? If it wants to create a new product, it may have to hire some extra designers and programmers. But what does it invest in? An office, some computers. The office could be rented, the computers will be obsolete in a few years. Ditto for Facebook. Amazon also needs some warehouses, and maybe some robots to move boxes around. In a few years the warehouses could be somewhere else and the robots will be replaced by better robots. It’s all short-term stuff.

Whenever a company makes an investment, it’s weighing its expected profits against two things: the cost of capital (for example, the interest rate it has to pay on the money it borrows) and the depreciation rate (how fast the investment becomes obsolete). In the Industrial Era, when a factory complex or a railroad might be around for half a century, depreciation was low. So the cost of capital really mattered. If interest rates dropped from 6% to 4%, all your calculations changed. Investments you’d been putting off suddenly made sense again.

But when the equipment you’re buying is going to be scrap in 3-5 years, the cost of capital doesn’t matter nearly so much. Cutting interest rates still motivates people to buy houses, because those are long-term investments. But it doesn’t motivate business investment much any more. Krugman looks at the huge interest rate spike of 1979-1982, when the Fed pushed rates up over 20%. Housing investment crashed. Business investment not so much.

If that was divergence was happening already in the early 80s, it’s even moreso now.

What’s that have to do with tax rates? Now comes the wonky part:

What does this have to do with taxes? One way to think about corporate taxes in a global economy is that they raise the effective cost of capital. Suppose global investors demand an after-tax rate of return r*. Then the pre-tax rate of return they’ll demand in your country – your cost of capital — is r*/(1-t), where t is the marginal tax rate on profits. So cutting the corporate tax rate reduces the effective cost of capital, which should encourage more investment.

Let’s work an example of that. Suppose global investors are looking for a 5% return on their investment after taxes. (That’s Krugman’s r*.) If the corporate tax rate is 35%, they’ll need to make a pre-tax return of 7.7%. (That’s 5%/(1 – .35).) So for every $1,000 you invest, you make $77, you pay 35% of your profit in taxes ($27), and you wind up with $50, or a 5% profit.

Now cut the tax rate to 21%. Now you only need to make 6.3% before taxes to wind up with 5% after taxes. For every $1,000 invested, you make $63, pay 21% in taxes ($13) and wind up with $50.

So in this example, the tax cut effectively reduces the cost of capital from 7.7% to 6.3%.

That would have been a big deal to Henry Ford or Andrew Carnegie. Jeff Bezos or Mark Zuckerberg prefer the lower rate, of course, but it doesn’t drive their decisions in the same way.

Hence Krugman’s conclusion: It’s not that cutting corporate taxes will have no effect on jobs or wages, but it’s going to work out to a huge loss of goverment revenue in exchange for a small number of jobs.

But the vision of a global market in which real capital moves a lot in response to tax rates is all wrong; most of what we see in response to tax rate differences is profit-shifting, not real investment. And there is no reason to believe that the kind of tax cut America just enacted will achieve much besides starving the government of revenue.

The end result. Krugman’s argument needs one more step, because he leaves one question unanswered: Why should you care if the government collects less tax revenue? OK, maybe the lost revenue flows mainly to rich shareholders and billionaire CEOs and only a few jobs are created. Maybe the overall effect on wages doesn’t amount to much. But if it’s something, isn’t that good? The taxman may bag a little less — or even a lot less — but why should American workers cry about that?

Over the last few decades, conservatives have done a good job of convincing many Americans that taxes just go down a rat hole and aren’t connected to the valued services government provides. (In states like Kansas and Louisiana, though, people are starting to see the relationship.) And for the moment, Republicans have stopped worrying about the budget deficits that they were so focused on during the Obama administration. Less revenue means bigger deficits, but, again, why should you care?

Because deficit phobia will be back someday. We are already looking at trillion-dollar deficits beginning in 2020, and that’s under the assumption that we aren’t in recession by then. (This economic cycle is already getting a little old; that’s why unemployment numbers are so low.) In any serious recession — and one always comes eventually — the deficit will top $2 trillion, which is much higher than the record Bush/Obama deficit of FY 2009.

There is only one pile of money big enough cover a shortfall like that: entitlements like Social Security and Medicare. (We could zero out the defense budget and still have a deficit.) When Republicans remember that they care about deficits, that’s where they’re going to look.

So American workers who cheer for the corporate tax cut are like Esau being grateful to Jacob for his porridge: In the long run, the tax cut they let the rich monopolize will cost them their birthright of Social Security and Medicare.

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Comments

  • Kaci  On June 18, 2018 at 9:52 am

    I also worry about the environmental impact of purchased equipment being scrap in 3-5 years. We need better ways to recycle it.

    • Elaine  On June 18, 2018 at 9:57 am

      That is not what this column is about.

      • Kaci  On June 18, 2018 at 10:01 am

        Hmm, I wasn’t aware that Doug prohibited discussion of other ideas brought to mind by his columns. I could’ve sworn I’d seen it happen in the comments before, but maybe I’m mistaken.

  • Elaine  On June 18, 2018 at 9:55 am

    More emphasis on the extremism of tax cuts in Kansas and Louisiana and how they tanked entire states needs to be explained, and often. Also, Trump and most of the GOP are poor at math. Always have been. They can’t add, subtract or divine consequences. Kansas certainly proves that. There is little imagination about what this country would look like without Social Security or Medicare (well, for all). Probably the Congo.

    • ADeweyan  On June 18, 2018 at 5:11 pm

      The problem I see with making too much out of the disaster in Kansas is that there is a very easy response (though, to be honest, I haven’t yet noticed anyone making this argument). Kansas only had control over the Kansas State taxes, and those are minor compared to Federal taxes. They just couldn’t go far enough to see the benefits start to roll in. I’m not arguing that myself, of course, but it seems like an obvious response for someone who believes that if you cut taxes enough, the increase in volume will make up for the decreased rates.

  • Michael Wells  On June 18, 2018 at 10:42 am

    I wish you would stop using “entitlements” to describe Social Security and Medicare. You are merely adopting the framing of the Republicans. “Social Security” is a catchall for a number of programs that include Social Security Disability programs and Social Security Retirement. “Medicare” includes several different health programs and is frequently confused with Medicaid, a health insurance assistance program for the low-income among us. I suppose I feel “entitled” to my Social Security Retirement, having paid into the system nearly my entire working life but only in the sense of a retiree from a company that provided a defined-benefit pension. The term “entitlement” connotes the attitude of the undeserving to money they didn’t “earn.” Sort of like one of my high school classmates who after a financially successful career, claimed that he “was going on the dole” because he had to sign up for Medicare Part A. I had to educate about the fact that unless he was working “off the grid,” he had been paying into that insurance system for about 35 years.

  • Martin malone  On June 18, 2018 at 1:03 pm

    So what is really going on with this tax cut is the same goal we have seen since reagonomics – starve the beast. Anything that cuts government revenue is good because in the long run, it will force the government to shrink. Republicans can’t do it directly, since, as Doug often points out, people actually like the benefits they get. So the devious path is to have big tax cuts and when the deficits appear, they say “we need to cut spending.” Big windfalls for their contributors are popular with their contributors. But it’s the libertarian, no tax ideologues who are driving this strategy.

  • jh  On June 19, 2018 at 3:18 pm

    That’s part of why I advocate the retention of federal tax dollars in the states that generated those tax dollars. (Or as I call it the unconstitutional wealth redistribution from productive states to welfare states.) That’s als0 why I advocate for the abolishment of FEMA which subsidizes the sloppy lazy red states who don’t pick themselves up and take care of themselves.

    Those tax dollars from Illinois could be better spent on Chicago than in some crap red state. Maybe then, we wouldn’t hear “But Chicago” as if one failing city with a high minority population somehow is an equitable comparison to the utter nonsense of Kansas.

    As for FEMA, I seem to recall a lot of nonsense from senators who should have understood how that kind of emergency funding had to be attached to an existing bill (say that covered funding for salmon or something non-hurricane Sandy related). it took over 3 months to get any financing. That’s bullshit. Especially since NY, NJ, CT are states that contribute to the US GDP. In contrast, look at the timing for Hurricane Katrina or Harvey. The only one that is longer is Puerto Rico and that’s because republicans/conservatives don’t think that brown people can be US citizens. I’d prefer a state or local cooperative of states FEMA rather than a national FEMA. If that’s what it takes for people to wake up and acknowledge how nice the services are, than that’s what we need to do.

    When I look around in my northeast state, my local government stock piles salt and snow supplies. They go around trimming trees. They go around maintaining bridges and so on. My neighbors and I stock up on supplies, water, gas, ice melt and do an inventory check on our shovels. We don’t wait for a handout. We don’t wait for the levees to break. (CA enforces a strict building code because of earthquakes. They don’t wait for the levees to break either.) But then, Louisiana wasted a billion dollar democrat governor earned surplus on Jindal’s tax cuts. Why couldn’t they spare even ten percent on routine maintenance? Why did they even need FEMA to come when Katrina was an easily preventable/mitigatable problem?

    As long as the conservatives get a cushion from blue state money or get their FEMA check on time rather than fixing the levees, we will have this nonsense. Conservatives don’t understand that their lives in those states are subsidized by hard working liberals. My state has federal income/state income/sales tax/property tax and probably a few more. Why is my state’s money not spent in state? Why can’t it fix my roads, my bridges, my schools, my business districts and so on? I suspect that my property or sales tax could be significantly reduced if my state’s federal tax dollars stayed in state. (Sorry – Sandy was my breaking point.)

    (And of course I would “help” those struggling states financially…for a price. Standard lending interest rates need apply. Possibly political kickbacks in terms of voting would be required. Certain inflammatory nonsense such as “coastal liberals aren’t real Americans. Only the heartland has real Americans” would be shut down because they need to be nice to the bank of blue states.)

    As for corporations – I wish we would tax revenue earned straight at the source. You make a billion dollars in the US, you pay taxes in the US. If you don’t want to pay taxes, you can’t sell in the US. After all, would a Bezos or a Zuckerberg actually make money in Afghanistan or Ireland? They need the disposable income that the US has to make their sales. I’d like to see the business owner who would say “Nope. I don’t want to sell in the US. The taxes are too high. I’m moving to Somalia.”

    • knb  On June 20, 2018 at 8:10 am

      You might be interested in this video of Tim O’Reilly’s talk at Google. He touches on a number of different things, but one of them is revising the tax code. He talks about not just tinkering with the rates, but creating a new paradigm. The economy is functioning on the wrong algorithm.

  • Moz of Yarramulla  On June 26, 2018 at 11:42 pm

    Greg Jericho just made a very similar argument for Australia. Half their interest is in paying less tax, but they also really like cutting the subsidies to poor people. “what have pvos ever done for me”?
    https://www.theguardian.com/business/grogonomics/2018/jun/26/dont-ask-who-benefits-from-tax-cuts-do-ask-who-will-pay-for-them

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