Republicans in Congress and the White House have clearly settled on a central theme to market recent plans to cut taxes on business: These cuts will end up boosting wages for American workers. As public relations, this theme is brilliant; too-sluggish growth in paychecks is a central concern for the American public. As economics, however, it’s bunk.
I work at the Economic Policy Institute, a think tank that has devoted enormous effort to understanding trends in American pay. For years our flagship publication has been the State of Working America, and in 2014, we launched the Raising America’s Pay initiative. We were the first to notice the divergence between economywide productivity and hourly pay for typical workers, and we have been the loudest voice inside the Beltway demanding that policymakers address the crisis in American pay.
These years of studying labor market outcomes led us to realize that policy decisions that affect workers’ leverage and bargaining power vis-à-vis their employers are enormously important in determining whether paychecks grow. Put simply, if a worker can’t credibly threaten to impose real costs on their employer if bargaining over wages breaks down, they have very little chance of getting raises. This explains why collective bargaining is so central to achieving healthy wage growth: If bargaining breaks down between an employer and a single worker, that doesn’t disrupt business too much. If the bargaining breakdown leads to an entire workforce not showing up to work, it’s a different story.
Similarly, if a worker threatens to leave a job unless they get a raise when the overall unemployment rate is very high, both sides know that the employer will be able to replace them easily with somebody currently jobless, so the threat isn’t credible. But if a worker threatens to leave when overall unemployment is low, the employer will have a much harder time recruiting to replace them, and the threat is real. This explains why wages grow faster when the economy booms and labor markets are tight.
Republican policymakers and their advisers are not likely to embrace this diagnosis of why wages have not grown anytime soon, but they do now realize the basic facts about sluggish growth in pay and its political salience. “We want our companies to hire & grow in AMERICA, to raise wages for AMERICAN workers, & to help rebuild our AMERICAN cities and towns!” President Trump declared in September. He and his GOP allies know they need to offer something they can claim is a wage-boosting policy, and they’ve decided that tax cuts will be this something.
It’s true that the economics textbook does offer them some support here. If post-tax profit rates were low and the cost of obtaining capital (or interest rates) were high, then corporate rate cuts (that were fully paid for) could in theory spark a chain-reaction of events that lead to higher wages. A corporate rate cut would boost post-tax profitability, which could spur firms’ demand for making productivity-enhancing investments. The savings needed to finance these investments could come from households saving more in response to the higher returns to corporate stock ownership. The resulting increased investment in plant and equipment would boost workers’ productivity, and this boost to productivity would make wage gains possible.
Why isn’t this series of bank-shots likely to work in the real world?
First, post-tax profitability has been historically high for years now while interest rates have been low. Yet business investment has been extraordinarily slow. Clearly, something besides depressed profitability or high interest rates is holding investment back. Second, real-world evidence — from the historical experience of the U.S. economy after tax cuts to international comparisons to the experience of U.S. states that have cut business taxes — offers no serious reason to think a wage bonanza will follow these tax cuts. Third, if corporate rate cuts are not paid for with spending cuts or other tax increases, then the boost to private savings they provide will be neutralized by a reduction in public savings (i.e., a rise in the federal budget deficit). This will choke off the financing needed to boost investment in productivity-enhancing plant and equipment by raising interest rates. Finally, without measures to boost workers’ leverage and bargaining power, there is no guarantee that any gains to productivity would actually reach employees’ paychecks.
In the end, a strategy of increasing workers’ leverage and bargaining power has a much higher likelihood of success in boosting wages. Ironically, corporate tax cuts aren’t just useless as a wage-booster, they’re likely even worse at spurring business investment than measures to boost typical workers’ leverage and bargaining power. Why? Because if wages finally do start rising reliably, that could lead firms to worry about higher salaries eating into profit margins and start to make productivity-enhancing investments to cut labor costs.
We’re happy to welcome Republicans’ newfound recognition that American workers need a raise. But we’ll hold our applause until they offer real solutions. Tax cuts for America’s richest businesses does not count.