by Joe Warta
North Carolina is set to phase out its corporate income tax by 2030. Proponents argue it would lead to more investment and higher wages for employees, but opponents argue it would lead to inflated corporate profits and concentrating more wealth at the top stratum of society. The U.S. Joint Committee on Taxation and Federal Reserve Board recently provided some important insight into that debate, but the Tax Foundation argued “let the reader beware.”
In November 2023, the Joint Committee on Taxation and the Federal Reserve Board jointly released a research paper reporting that the corporate tax cuts from the 2017 Tax Cuts and Jobs Act (TCJA) resulted in minimal wage growth from 2018 through 2019. This finding was seemingly a contradiction of claims by proponents that savings from corporate tax cuts would find its way into the pockets of workers. Tax Foundation economist Alex Durante pointed out, however, that there is more to the story than the research paper can show.
Durante argued that while there are useful pieces of information to be found in the study, it provides only a small part of the picture. To study effects only from 2018 through 2019 is a short-term view, Durante explained. The more accurate view could be found by studying the long-term impacts.
There are several different components of how corporate tax cuts affect corporations and capital investment. Durante pointed out that corporate tax cuts increase the marginal rate of return on investment by reducing tax expense, which increases profits generated for the firm. But it also increases profits for earlier investments just now bearing fruit — because those investments had previously been calculated using the old tax rates. With the new, lower tax rates, actual profits are higher than previously anticipated.
The one-time reduction in tax expense is more a windfall than an actual increase in income. It’s the windfall that is mostly being observed in the Committee on Taxation and Federal Reserve’s study. The windfall component of tax savings shouldn’t be expected to lead to higher wages, though it would lead to an increase in profit and shareholder returns in the short run. This is because, in corporate management, one-time windfalls are seldom if ever relied upon to make long-term decisions. A one-time, nonrecurring windfall will not sustain permanently increased wages, so it is instead reinvested in the company or given to shareholders in a one-time dividend.
So what happens in the short term is exactly what opponents of corporate tax cuts expect to happen: little increase in employee wages, but inflated corporate earnings and distributions of those earnings. But that argument begins to have less sway the longer the tax cuts are in effect.
Indeed, as the Tax Foundation pointed out, the long-term impacts were already showing preliminary signs of working: the tax cuts did lead to significant increases in labor demand and investment. So, while wages were unlikely to increase in the short-term, investment and growth takes time, so the increase in wages should be expected to occur after several years.
Taxation is a slow-moving mechanism for economic change. The 2017 tax cuts went into effect for tax year 2018, for which tax returns were filed in 2019. So tax savings would not truly be realized until 2018 at the very earliest, but more likely would be seen in 2019 when tax returns had been filed and the true numbers were figured. So to consider wages from 2018 through 2019 is far too early for any substantive impacts to have truly surfaced.
Finally, the study does admit that many of the provisions of the TCJA are set to expire. It’s also reasonable to note that some businesses have not and will not base their employment decisions off temporary tax provisions. However, its overall reduction of the corporate tax rate to a flat 21 percent is permanent (it had been a progressive rate ranging from 15 up to 35 percent).
This study and the Tax Foundation’s analysis are especially relevant to North Carolina, as it prepares to phase out its own corporate income tax. Opponents argue that repealing the corporate income tax will simply lead to higher corporate income and little benefit to workers — and focusing exclusively on a short-term view may seem to support that proposition. But with economic policy, it is vital to look at the long-term impacts. As the Committee on Taxation and Federal Reserve’s study showed, the federal corporate income tax cuts lead to an increase in investment and demand for labor, just as proponents expected.
So do corporate income tax cuts lead to increases in workers’ wages? Careful analysis suggests that short-term benefits may predictably accrue to the company, while in the long term workers will receive the lion’s share of gains.