Countering Krugman: Workers to see near-term gains from corporate tax cuts

By cutting the statutory corporate tax rate and by permitting investment expenses to be immediately deducted from corporate income, the new tax law encourages corporations to enhance their workers’ productivity by investing in structures, equipment and software.

The additional investment will accumulate over several years, which means that the full effect on productivity and wages will not be felt for several years.

{mosads}However, Economics Nobel Laureate Paul Krugman further asserts that there are essentially no benefits for workers in 2018, despite the fact that a number of corporations have announced bonuses for workers while saying that the bonuses derive from the new tax law. 

The simplest model of investment and worker productivity agrees that aggregate wage increases would not be discernible in the first year following a permanent and unanticipated capital income tax cut because of the time that it takes for investment to be planned, executed and translated in to greater worker productivity.

But Krugman, Obama economic adviser Larry Summers, and I, among others, agree that our economy and this tax cut have some meaningful differences from the simple model. One of those differences is that President Trump’s signature last week was not an entire surprise.

The U.S. had been behind most of the world in cutting its corporate rate, and it was largely a matter of time until the U.S. did the same, especially in 2016 when Republicans won the White House and both houses of Congress. 

Throughout 2017, businesses were making plans understanding the very real possibility that federal corporate tax rates would be lower, and the execution of those plans are already adding a bit to worker productivity.

The simple model also ignores that a lot of businesses are not organized or taxed as U.S.-based C-corporations, which are the types of corporations that have been subject to high statutory rates by worldwide standards.

This has resulted in too little business activity occurring with the legal and organizational advantages of the C-corporation, and productivity has suffered as a result of companies’ keeping activities away from the high C-corp rates.

Reallocating activity to U.S.-based C-corporations can happen more quickly than the building of new structures or manufacturing new equipment does. This means that part of the productivity effect can occur quickly too. 

The simple model also treats labor costs as variable, which is a reasonable treatment for multi-year time frames. But over a period of a few weeks or months, which is the time frame discussed by Professor Krugman, much of the labor costs are slow to adjust, due primarily to the fact that it takes time to attract and sign good employees.

With businesses anticipating productivity growth over the next several years, it makes sense for them to take some immediate steps to solidify their workforce. (It’s odd that Krugman missed this effect: he frequently writes about the “JOLTS” labor data, the entire point of which is that labor costs adjust slowly from the perspective of weekly or monthly data).

I agree with Professor Krugman that actions speak louder than words in matters of economics. Although they sometimes agree, often businesses say one thing and do another. This is especially true when the federal government uses its regulatory might to encourage businesses to say the “right thing,” as it did when it rolled out the Affordable Care Act a few years ago.

But it is inaccurate to claim that workers must wait before seeing any benefits of the corporate tax cut.

Casey Mulligan is a professor of economics at the University of Chicago. His recent research has focused on non-pecuniary incentives to save and work and how the economy affects policy. His two recent books are, “The Redistribution Recession: How Labor Market Distortions Contracted the Economy,” and “Side Effects: The Economic Consequences of the Health Reform.”