No, the GOP Tax Plan Won't Give You a $9,000 Raise

Jason Furman (PIIE)

October 22, 2017

The White House Council of Economic Advisers claimed in a report released last week that the cuts to the corporate tax rate contained in the Republican tax-reform proposal would raise average annual household incomes by more than $4,000. They called this a "very conservative" estimate. A well-designed business-tax reform has the potential to raise productivity and wages. But this proposal is not well-designed, and flawed analysis only makes achieving well-designed reform less likely.

On the individual side, the Republican plan offers almost no direct benefit to the middle class. Many details are still missing, but from what we know so far it would largely be a wash for most households. A larger standard deduction and child tax credit would roughly offset the elimination of personal exemptions and the increase in the lowest bracket from 10 to 12 percent.

The net effect would be some simplification and fewer distortions, like the mortgage interest deduction, but not much of a decrease in the taxes paid by most households. Those households with the highest incomes would get large benefits from reductions in the top rate, repeal of the estate tax, and a new preferential rate for certain types of income.

The bigger debate is about who benefits from a reduction in the corporate rate from 35 percent to 20 percent, which would reduce federal annual revenue by about $200 billion. An important economic lesson about taxes is that the one who writes the check is not necessarily the one who bears the cost. The Treasury Department and the Joint Committee on Taxation operate under the assumption, informed by decades of research, that about 25 percent of the corporate tax bill is ultimately paid for by workers in the form of lower wages. Recent peer-reviewed research has found labor's share of the corporate tax burden ranging from lower than 25 percent to as high as 50 percent.

Economists are likely never to agree on who pays the corporate tax because the true answer is . . . it depends. In the long run, mobile capital can avoid taxes while immobile labor cannot, so labor pays a higher share. On the other hand, much of the corporate tax increasingly falls on returns to monopoly power and other rents, putting a growing slice of the burden on shareholders.

The White House claims that the average household would see between $4,000 and $9,000 more in its paychecks every year. But if all 125 million households got a raise like that, it would amount to an annual increase in total wages of between $550 billion and $1.1 trillion. That's between 275 percent and 550 percent of the total cost of the $200 billion corporate tax cut—implying a supply-side effect that's more than a little far-fetched.

Although the White House makes much of the importance of peer-reviewed research, their estimates of the wage effects from a cut to the corporate tax rate are based on parameters from a few papers written a decade ago, none of which were peer-reviewed, and most of which were never published. One of the authors of the paper used to justify the $9,000 claim took to Twitter to say that the CEA report "misinterprets" his findings, which found that labor paid 45 percent to 70 percent of the corporate tax, not 550 percent as claimed by the White House.

Moreover, the parameters used by CEA are based on estimates for US states or much smaller and lower-income countries. North Carolina and Estonia might get much more inbound investment with a lower rate, but the trick would not work nearly as well for an economy as big as America's. Many companies need to be in the United States for reasons quite apart from taxes. The United Kingdom, an advanced and relatively large economy, is a more relevant example. Its experience of a 0.3 percent annual real wage decline since 2007, following its cutting its corporate rate from 30 percent to 19 percent, does not inspire much confidence in claims about large wage effects.

According to my calculations, the White House methodology yields the absurd conclusion that eliminating the corporate tax altogether would boost annual household wages by up to $20,000. In their analysis, the administration counts only the purported benefits from tax cuts without factoring in the costs of higher deficits due to lost revenue. But the need to raise revenue to finance government spending and avoid large-scale borrowing is the reason we have taxes in the first place.

Absent significant spending cuts, lower government revenue will lead to higher deficits. This, in turn, will either reduce capital formation and thus long-term growth, or it will maintain investment levels at the cost of skyrocketing foreign borrowing. The empirical results cited by the White House ignore this issue, basing their estimates either on assumptions that tax cuts are paid for with new lump-sum taxes on all households or on the experience of countries like the United Kingdom and Germany, which paid for corporate rate reductions with higher value-added taxes and other base broadeners.

Well-designed business-tax reform would include permanent expensing, elimination of the corporate interest deduction, a more robust and competitive international system, and fully paid-for reductions in the corporate rate. Such changes could help boost wages modestly over time. But the current plan falls short on all of these counts—and it is workers who will ultimately bear the cost of the White House's wild claims.

Mr. Furman, a professor of practice at the Harvard Kennedy School, was chairman of the White House Council of Economic Advisers, 2013–17. Follow @jasonfurman on Twitter.