The Tax Trump Would Cut if He Sincerely Wanted to Create Jobs and Increase Wages

[Cross-posted from]

A major problem with Trump’s proposal to decrease the top corporate income tax rate and the rate of tax paid by owners of businesses not subject to corporate tax is that it won’t accomplish its stated objective of creating jobs and increasing wages.

Does that mean the President has been lying to us? Well, yes.

This isn’t rocket science. Corporations seek to maximize the profit remaining after the payment of all costs, including income tax. So do the owners of businesses not subject to corporate income tax. The income tax is one cost businesses incur in getting to after-tax profit. But it’s unique among costs in that it does not directly impact the pre-tax profit of a business. Reducing the income tax rate, therefore, doesn’t free up any pre-tax dollars.

Put another way, changing the rate of income tax won’t change what a business does to maximize the profit it has remaining after payment of income tax. Regardless of the rate at which a business pays income tax, it still will spend in the manner that maximizes the income it has prior to the payment of income tax, then pay tax at the rate charged.

Which means a reduced income tax rate won’t cause businesses to spend more on wages. Increased spending on wages is of course the only way to create more jobs or increase worker pay, or both.

The way an income tax change can impact how a business spends its pre-tax dollars is if it changes how a given expenditure will impact the business’ income tax liability compared to other expenditures. Trump’s proposal to allow the immediate deduction of the full cost of new equipment is an example of this type of change. By accelerating the deductibility of that cost for income tax purposes, Trump’s plan reduces the after-tax cost of spending on equipment, effectively making equipment purchases cheaper.

But the Trump plan doesn’t change the manner in which wages impact a business’ income tax liability. Wages already are 100% deductible by a business in determining its tax liability. Whether or not Trump’s plan passes, businesses will pay more in wages only if doing so will increase revenue by more than the wage increase.

Now, consider the impact of a tax cut Trump hasn’t proposed: A cut to the employer portion of Social Security and Medicare taxes, also known as the employment tax. That’s a tax businesses pay based on the wages they pay out.

Which means that reducing employment taxes reduces the cost of paying workers. And it’s a direct, dollar-for-dollar, reduction. From the perspective of the business owner, a reduction in employment tax is the same as a reduction in the cost of employee benefits, for example, health insurance. In either case, the cost reduction makes it cheaper to have an employee around. And when it’s cheaper to have employees around, a business may choose to have more employees around (job creation) or use the cost savings to pay employees more, thereby helping it to keep its current employees and attract new ones.

The bottom line is that if Trump truly wanted to use tax policy to create jobs and increase worker wages, his tax proposal would look entirely different. Instead of proposing cuts in the corporate income tax rate and the rate of income tax paid by owners of businesses that don’t pay corporate tax, Trump would be proposing an employment tax cut for businesses. Which tells us that Trump’s true objective in his tax plan is not what he’s represented it to be.

14 thoughts on “The Tax Trump Would Cut if He Sincerely Wanted to Create Jobs and Increase Wages”

  1. So we still haven’t paid for Bush’s two wars, we have to rebuild Florida, Texas, and Puerto Rico, and we’re about to increase an already bloated defense budget.

    Sure, seems like a good time to give rich people a tax break, haven’t they suffered enough?

    • Deleted – If JH wants to post under a pseudonym, it must be “Thucky,” as that’s the name by which we know him here.

      • Maybe you could explain how 8 years of economic growth and relative peace under Obama is a quagmire?

        You do remember GW Bush, right? 2008?

    • Deleted – If JH wants to post under a pseudonym, it must be “Thucky,” as that’s the name by which we know him here.

  2. Bob,
    You were not clear whether or not you support this supposed job creating tax cut. Do you? Just curious.

    • If I were assigned the task of devising a tax cut to stimulate job growth, an employment tax cut would be a leading contender.

      But I’m more of a demand-sider, John. I would tax the rich more and spend the revenue on infrastructure and other job generating projects to improve the common good.

        • Dollars are fungible, John. There’s nothing to say other revenue couldn’t be allocated to the fund. In fact, I think that’s been done before.

  3. One thing that I think needs more study is the question of why we use *payroll* taxes, as opposed to income taxes, to fund Social Security and Medicare. Unearned (passive) income such as dividends, capital gains, and rents, is already subject to preferential tax treatment, and there are numerous loopholes, such as the carried interest loophole and paying C-level executives with stock options, which allow high-earning workers to legally shift wage income into preferentially-taxed ‘unearned-in-name-only’ income.

    I would also add that an expansion of the EITC – perhaps extending out the phase-out range – would be great to stimulate employment among the lower-income segment of the population, and the mortgage-interest deduction is a political sacred cow that is also bad economic policy.

    Personally, I would be fine with a statutory rate reduction (particularly reducing the rates on income under $50,000) if there were additional steps taken to ensure that we closed loopholes and deductions not in the public interest.

    • Because they are not welfare programs but insurance programs that beneficiaries and their employers pay for. Or so the legend goes.

    • “I would also add that an expansion of the EITC…would be great to stimulate employment…”

      NOTE: Before I say anything else, my comments are based on the “EITC” you mentioned as being the Earned Income Tax Credit. If I am wrong in that assumption, then my comment/question makes no sense.

      How would the Earned Income Tax Credit stimulate employment? I have always thought that, in general, tax credits do little for the economy other than putting extra money in the pockets of low income workers. I am not arguing the point, Edward, I am genuinely curious as to how that would work.

      “…additional steps taken to ensure that we closed loopholes and deductions not in the public interest.”

      I think that would be a standard that would be nearly impossible to meet. The problem…well, one of the problems with the concept is who decides what is in the public interest? My definition of the public interest is, I’m certain, very different from yours. We see the world differently, Edward, and we have different standards by which we judge these things.

      ” Unearned (passive) income such as dividends, capital gains, and rents…”

      We disagree on the very definition of some major forms of income. Dividends, capital gains, rents, etc., are hardly “passive” income sources, nor are they unearned. Every one of those categories requires a LOT of oversight, management, and effort to make them “income” rather than a loss. If there is the extra income that allows you to invest, that means you worked hard to have that money available. I know I earn every dime I make and I am anything but passive in doing so. Some day, when you have money available for investing, I think you will appreciate my position more. ;o)

      • The EITC acts as a negative income tax over the low-to-moderate income spectrum. If we assume that workers have some flexibility in allocating their waking hours between work and leisure, a negative income tax acts much like an increase in the utility derived from work via an increase in the (after-tax) wage rate. An economic agent at the margin, in the presence of a negative income tax, would be willing to work longer hours, or accept commensurately lower wages from their employer because the difference is made up at the margin by the EITC. Similarly, there is also a tradeoff at the extrinsic margin, where workers are indifferent between entering the labor force at prevailing wages and withdrawing from the same.

        Perhaps surprisingly, even Milton Friedman (hardly a paragon of left-wing thought) supported a negative income tax mechanism as a preferred method of welfare because it encourages, rather than discourages, labor force participation.

        This is, of course, independent of demand-driven stimulus as a result of putting more income into the hands of lower-income people, who generally have a higher marginal propensity to consume.

        I won’t disagree with you on your second point. That is, of course, a normative and a political question of what tax policies best serve the public interest and what the optimal rate schedule and allowable deductions should be. Economics can, at best, provide guidance as to who benefits, who suffers, and what the changes in incentives are likely to cause. Other disciplines have to address the questions of whether a change is ‘worth it’.

        As for the third point, there are a few factors at play. If you are talking about property management or investment research & consulting, that is still labor. I don’t really do any work with regard to my IRA, though. Buy some mutual funds, and worry about other things. So, maybe I take a different viewpoint.

        Another point is that the traditional argument I’ve heard in favor of lower tax rates for investment income is to spur additional investment. At least right now, we have a glut of cash instruments on corporate balance sheets, companies are routinely spending money on dividends and stock buybacks rather than on physical investment and R&D activity, and real interest rates are effectively zero. Those are not the markers of an economy where a lack of loanable funds is holding growth back, but instead one where physical investment is stymied by a lack of demand.

        Yet another consideration is that there is a greater elasticity for income derived from work relative to that from capital. If marginal tax rates on work income were to double overnight, I think you’d see a fair number of people cutting back on hours, taking weeks off, and so forth. If marginal tax rates on investment income increased, I don’t think you’d see such a dramatic shift where investors start pulling their money and start buying more and bigger yachts and diamonds. This would suggest that wage & employment taxes are more distortionary and create higher deadweight loss than do investment taxes.

        • Edward, that is an excellent explanation of what you meant when you suggested the EITC could work as an economic stimulant. I really appreciate your taking time to answer my question because I understand it better and am open to the idea.

          You, and people like you, are the main reason I enjoy posting on this blog so much. I learn a lot here and I am always fascinated with new ideas and perspectives. Thank you, again!

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