Businesses seldom raise wages due to a sense of corporate benevolence. Rather, wages rise when the demand for workers increases. This forces businesses to increase wages out of self-interest, to keep their employees from being hired away by competitors.
This basic tenet of economics explains why corporate tax cuts produce higher wages for workers.
That may seem counterintuitive. Most people think a corporate tax cut just means bigger profits for businesses — profits that are used to line the pockets of the rich: the owners, corporate executives, and shareholders. But what actually happens is way more complicated, and it’s very good news for workers.
First, let’s look at the big picture, the U.S. corporate income tax rate is one of the highest in the world. On top of the 35 percent federal tax rate there are state taxes, bringing the average top corporate rate to nearly 40 percent of taxable income. Other provisions of the tax code — such as not allowing firms to fully deduct their capital expenses — help make the U.S. business tax environment one of the most burdensome in the world.
That’s something that investors, both foreign and domestic, weigh heavily when deciding where to build their new factory or back a new business venture. Put another way, our current business tax environment discourages investment in America. Foreign and domestic investment dollars still flow, but they flow elsewhere, as investors choose to set up shop in other countries.
Today, business investment in the United States is unusually low. Investment per worker is 8 percent below the historic norm, according to a 2015 report by the Chicago Federal Reserve Bank. And subpar investment creates huge problems.
Businesses make investments, in things like machinery and new technology, so that their employees can become more productive. As employees produce more, profits go up, enabling the business to hire more workers and make even higher profits. But the hiring spree benefits workers as well as businesses: the increased demand for workers leads to higher wages for all.
Recent research by economist Salim Furth concludes that making up the “lost” 8 percent of investment per worker “would increase wages between 13 percent and 20 percent” for all Americans. That could be as much as a $10,000 raise for the typical American family (median annual wage approximately $50,000 a year), that would mean a raise of $6,500-$10,000.
Comprehensive corporate tax reform — a package that includes both a lower tax rate and the immediate write-off of capital expenses — could increase American wages by even more than 20 percent, according to some estimates.
Ridding the tax code of its current bias against investment would unleash a torrent of new investment in American businesses and American workers — and it’s the workers who pocket most of the profits.
A review of 10 separate economic studies published between 2007 and 2015 concluded that, when corporate taxes are cut, workers receive almost all of the benefit through higher wages. That’s because more than 75 percent — and most likely the entire cost — of the high corporate income tax is being passed on to workers in the form of lower wages. No wonder, then, that lowering the rate and making America a more attractive place to do business will benefit workers the most.
Anemic economic growth since the great recession, the sluggish rate of business start-ups, and reduced entrepreneurship — all are partially the result of historically low rates of U.S. investment. Tax reform can remake America into a top global destination for business investment, and a far more rewarding workplace for American workers.
Adam N. Michel is an analyst specializing in tax and budget issues at the Heritage Foundation’s Roe Institute for Economic Policy Studies.