The Cure for Wage Stagnation - Lower Corporate Taxes

The Cure for Wage Stagnation
A plethora of studies from around the world agree: Lower corporate tax rates equal higher wages.

By
Kevin A. Hassett and Aparna Mathur
Aug. 14, 2016 5:40 p.m. ET

The populist anger of this election cycle stems, at least in part, from consistently bad economic news. While the overall U.S. economy has been inching forward, most peoples’ lives have barely been improving at all. The average hourly wage for manufacturing workers was $20.83 in June 2006, in current dollars, according to Bureau of Labor Statistics data. Adjusted for inflation, it is only about a dollar higher today.

The dissatisfaction of working-class voters in both parties is understandable. Yet this presents a once in a lifetime policy opportunity. If the next president has a plan to increase wages that is based on well-documented and widely accepted empirical evidence, he should have little trouble finding bipartisan support. If politicians in Washington oppose the president’s ideas, he can, as Ronald Reagan did, go over their heads to the outraged voters.

Fortunately, such a plan exists. Regardless of who is elected in November, workers from both parties should unite and demand a cut in corporate tax rates. The economic theory behind this proposition is uncontroversial. More productive workers earn higher wages. Workers become more productive when they acquire better skills or have better tools. Lower corporate rates create the right incentives for firms to give workers better tools.

Leaders from both parties have proposed lowering America’s 35% corporate tax rate, the highest in the developed world. President Obama has called for cutting it to 28% (25% for manufacturers), while Donald Trump proposes 15%. Hillary Clinton is the outlier. To the detriment of her working-class supporters, she has failed to back even a minor cut to corporate taxes.

What proof is there that lower corporate rates equal higher wages? Quite a lot. In 2006 we co-wrote the first empirical study on the direct link between corporate taxes and manufacturing wages. Our approach was highly intuitive and drew on a large literature exploring who really pays the taxes that government collects.

Back then it was widely accepted, for example, that sales taxes are not necessarily paid by consumers. If the government charges a 10% sales tax, goods prices might go up 10%, in which case consumers would pay the whole tax. On the other hand, goods prices might go up by less than 10%, in which case the retailer would have smaller profits. Processing massive quantities of data, economists found by the early 2000s that prices tend to go up about one for one with sales taxes. Sales taxes are thus borne mostly by consumers, not firms.

We applied a similar method to study the impact of corporate taxation on the wages of blue-collar workers. If a higher corporate tax reduces the return to capital, then capital may move abroad. This outflow could reduce the productivity and compensation for domestic workers, who are relatively immobile. So just as a sales tax might have an impact on the final goods price, a higher corporate tax might have an impact on wages. If wages go down when corporate taxes go up, the worker is left holding the tax bag.

Our empirical analysis, which used data we gathered on international tax rates and manufacturing wages in 72 countries over 22 years, confirmed that the corporate tax is for the most part paid by workers.

This result was controversial at first, and appropriately so. Scientific and economic progress flows from attempts to question and replicate. There has since been a profusion of research that confirms that workers suffer when corporate tax rates are higher.

In a 2007 paper Federal Reserve economist Alison Felix used data from the Luxembourg Income Study, which tracks individual incomes across 30 countries, to show that a 10% increase in corporate tax rates reduces wages by about 7%. In a 2009 paper Ms. Felix found similar patterns across the U.S., where states with higher corporate tax rates have significantly lower wages. In another 2009 paper, Ms. Felix and co-author James R. Hines of the University of Michigan discovered that the effects of lower tax rates are especially strong for union workers.

Confirmation has come in a number of additional settings. Harvard University economists Mihir Desai, Fritz Foley and Michigan’s James R. Hines have studied data from American multinational firms, finding that their foreign affiliates tend to pay significantly higher wages in countries with lower corporate tax rates. A study by Nadja Dwenger, Pia Rattenhuber and Viktor Steiner found similar patterns across German regions, and a study by Clemens Fuest, Andreas Peichl and Sebastian Siegloch found the same across German municipalities.

The most recent paper to find significant effects on wages was released in May and will soon be published by Canadian economists Kenneth McKenzie and Ergete Ferede. They found that wages in Canadian provinces drop by more than a dollar when corporate tax revenue is increased by a dollar. Similar patterns have been identified when Canadian economists have studied individual-level income data.

These studies and others convincingly demonstrate that higher wages are relatively easy to stimulate for a nation. One need only cut corporate tax rates. Left and right leaning countries have done this over the past two decades, including Japan, Canada and Germany. Yet in the U.S. we continue to undermine wage growth with the highest corporate tax rate in the developed world.

Why are we stuck in such a bad place? A key factor has been the intransigence of Democratic politicians, such as Mrs. Clinton, whose plan to increase wages is to keep taxes high at the corporate level, increase taxes on business income at the individual level, and to punish firms that move overseas in response to these high taxes.

This anti-corporate policy may be music to the ears of supporters of Bernie Sanders and Elizabeth Warren and the Democratic Party’s left wing, but it will make the lives of ordinary Americans worse. Wage growth will continue to be disappointing as long as the U.S. has the world’s highest corporate tax rate. Denying the need for lower corporate rates may be effective populism, but it is causing real harm to America’s workers.

Mr. Hassett is director of research for domestic policy at the American Enterprise Institute, where Ms. Mathur is a resident scholar.