Overview

The legislative process leading to the enactment of the Tax Cuts and Jobs Act this past December was short and contentious. Proponents of the legislation made their case largely based on claims about economic growth. Opponents disputed these claims and further argued that the legislation would benefit the most fortunate, harm the less fortunate, and require future spending cuts or other policy changes that would exacerbate these inequities. Unsurprisingly, these starkly different predictions about the economic consequences of enacting the legislation now are grist for an ongoing dispute about the interpretation of U.S. economic data and other indicators that could shed light on the law’s effects.

This issue brief offers a guide to assessing the economic effects of the legislation. There are two critical questions that must be answered to assess the effects of the new law on the economic well-being of the public. The first is who bears the burden of the taxes that were cut and thus will benefit from the cuts. The second is how large the increase in the federal budget deficit that results from the tax cuts will be. To answer these questions, economists and policymakers should be looking at three primary outcomes:

• Wages rates for workers
• The return on business investment
• Future federal budget deficits

A central purpose of the Tax Cuts and Jobs Act was cutting corporate taxes. Proponents of the legislation, however, typically argue that the long-run economic incidence (or burden) of corporate taxes primarily or exclusively falls on workers rather than shareholders, and thus workers will be the true beneficiaries of the legislation. How can we tell if the economic incidence of the tax cuts does, in fact, fall on workers? Differences between statutory incidence (who is legally obligated to pay a tax) and economic incidence (who bears the burden of a tax) are mediated by price changes. In the case of the corporate tax, the relevant prices are wage rates and investment returns. (To an economist, wage rates and investment returns are prices just like the price of a car or a sandwich. Wage rates are the price of labor, and investment returns are the price of a dollar today relative to a dollar in the future.) To shift the benefits of a corporate tax cut from shareholders to workers, wage rates must rise, and the return on business investment must fall. Thus, changes in wage rates and the return on business investment should be central to any evaluation of the law.

The legislation also—by all credible estimates—increased the federal budget deficit. This increase in the deficit will require changes in future fiscal policies to offset the cost of the tax cuts. These changes could take the form of explicit tax hikes or spending cuts, or they could take the form of implicit tax hikes or spending cuts when legislation that otherwise would have been enacted is not enacted. And they need not occur in the short run (though they may). Exactly how large any required fiscal changes will need to be depends on exactly how large the impact of the legislation on the federal budget deficit is. This is why the ultimate fiscal consequences of the legislation is also a key outcome that needs to be evaluated.¹

In assessing the impact of the legislation on these three outcomes, it is important to keep in mind that wage rates would likely have increased even in the absence of the legislation, given the state of the business cycle and long-term trends. That means it is not enough simply to compare future wage rates to their levels today. Nor is it enough to compare wage rates to what they would have been according to projections released prior to the law, as realized economic outcomes will differ from those projections for numerous reasons other than the enactment of the Tax Cuts and Jobs Act. It will take years for academics to conduct research into the effects of the law, and the interpretation of the research findings will remain subject to dispute even after they begin to come in.

In the short term, policymakers and economists will be engaged in a much more speculative exercise of attempting to parse limited and incomplete data for signs of the law’s effects. But while it will take time to both realize and evaluate the long-term effects of the legislation, one thing is clear about the short run: The Tax Cuts and Jobs Act sharply cut corporate taxes. And every month in which wage rates are not sharply higher than they would have been absent the legislation, and investment returns are not sharply lower, is a month in which the benefits of those corporate tax cuts accrue primarily to shareholders.

Changes in wage rates and investment returns will determine who benefits

The primary metric for judging public policy should be the well-being of the public. The two critical questions for assessing the impact of the Tax Cuts and Jobs Act on well-being are who bears the burden of the taxes that were cut and how large an increase in the federal budget deficit the new law will cause. An answer to the first will determine who benefits from the tax cuts and an answer to the second will determine the size of the fiscal policies required to offset the cost of the Tax Cuts and Jobs Act of 2017.²

Who bears the burden of the taxes that were cut?

The new law cut taxes, on average, for both individuals and corporations in the near term. The individual tax cuts expire after 2025. Most of the corporate tax cuts are permanent. But several revenue-raising corporate provisions are scheduled to take effect in the future. A provision increasing taxes on individuals through slower inflation adjustments and the repeal of the mandate to purchase health insurance imposed by the Affordable Care Act are also permanent.

As is well known, economic incidence often differs from statutory incidence. Payroll taxes, for example, are split evenly between workers and their employers as a statutory matter, but economists typically assume that workers bear the burden of payroll taxes in the form of lower wages.

In the case of the Tax Cuts and Jobs Act, the primary question in dispute is who bears the burden of the corporate income tax. Most proponents of the legislation argue that the long-run economic incidence of the corporate tax is primarily or exclusively on workers rather than shareholders, and thus workers will be the true beneficiaries of the legislation. Most opponents argue that workers bear only a small portion of the tax, and most of the burden is borne by shareholders. How can we tell if the economic incidence of the tax cuts does, in fact, fall on workers? Differences between statutory incidence and economic incidence are mediated by price changes; in the case of the corporate tax, the relevant prices are wage rates and investment returns.³

If a corporate tax cut causes returns to fall and wage rates to rise, then the incidence of the tax cut shifts from shareholders to workers.⁴ Thus, a critical question for evaluating the incidence of corporate tax cuts is the size of any resulting change in wage rates and investment returns.⁵ Wage increases could take the form of either cash or benefits. Thus, unless explicitly stated otherwise, references to wages in this brief include benefits.⁶

Note, however, that there is no universally applicable allocation of the burden of corporate taxes among economic actors. The incidence of different provisions is likely quite different. The Tax Policy Center, for example, makes different assumptions about the economic incidence of changes in the corporate rate and changes in the tax treatment of investment in equipment and structures. Additional complexities come into play in the case of the transition between tax systems because the question of who benefits in the long run may differ from the question of who benefits in the short run. Indeed, even most economic theories that suggest a substantial long-run burden of corporate taxes on labor imply substantial short-run gains for shareholders from corporate rate cuts, and thus, in present value, an important portion of the benefits of the corporate tax cuts in the new law will accrue to corporate shareholders. In addition, even in theories under which a deficit-neutral corporate rate cut would deliver large long-run gains for workers, deficit-financed corporate rate cuts often will not.

This issue brief examines estimates of the change in wages resulting from the Tax Cuts and Jobs Act after 10 years implied by the macroeconomic analyses of the Tax Policy Center, the Congressional Budget Office, the Penn Wharton Budget Model, the Tax Foundation, and the White House Council of Economic Advisers. The Tax Policy Center estimated that the law would increase wages by less than 0.1 percent after 10 years. The Congressional Budget Office estimated an increase of about 0.3 percent in the same year. The Penn Wharton Budget Model produced two estimates of the impact on wages, about 0.25 percent and 0.8 percent. The Tax Foundation estimated an increase of about 2 percent, and the White House Council of Economic Advisers estimated increases between 5 percent and 11 percent.⁷ All of these estimates compare wages in 2027 to what they would have been in that year had the legislation not been enacted.

The analysis focuses on 2027, as estimates for this year are relatively less affected by the then-expired individual tax cuts, which in certain models could reduce the wage gains due to the increase in labor supply. Moreover, as any increase in the wage rate resulting from the corporate tax cuts would likely manifest gradually over time, evaluating effects in year 10 offers a more generous assessment of their effects. Note, however, that the wage estimates cited here also include effects attributable to changes in the taxation of noncorporate businesses. These effects likely account for a relatively small portion of the total change in most cases.

These estimates imply widely varying labor incidence of the corporate tax cuts in the Tax Cuts and Jobs Act, ranging from near zero for the Tax Policy Center to multiples of the conventional revenue estimate for the Council of Economic Advisers.⁸ As a reference point, wage rates would need to increase by about 1 percent above what they would have been in the absence of the law to shift the benefits of the corporate tax cuts from shareholders to workers—and even more if revenue-raising provisions of the new law scheduled to take effect in the future are delayed or repealed.⁹ (See Figure 1.)

Figure 1

Corresponding to each of these estimates of increases in the wage rate that would result from the Tax Cuts and Jobs Act is an estimate of a decline in the return on investment that would also result. Estimates of the reduction in returns, however, are less frequently reported in published results, and no estimates are presented here. In the models typically used to evaluate the macroeconomic effects of changes in tax law, the same underlying mechanism—an increase in investment—delivers both an increase in wage rates and a reduction in investment returns in response to a reduction in the corporate tax rate (all else being equal). Thus, if wages are estimated to rise, then the return on investment will be estimated to fall.

In more general models, other mechanisms could be at work. Changes in the corporate tax rate, for example, could affect wages through an effect on the allocation of profits between owners and workers as a result of bargaining. For purposes of evaluating the overall effects of the legislation on well-being, though, it is more important to know by how much wage rates and the return on investment change than precisely why they do.

Estimating the effects of the new corporate tax cuts on wage rates and returns is not a simple exercise. Changes in wage rates and investment returns must be measured relative to the counterfactual in which the new law was not enacted but all other policies remained the same. It is not enough to say, for example, that wage rates have increased relative to their level at the time of enactment, as that would almost certainly have happened even without enacting the tax legislation. Nor is it enough to compare the effects of the tax cuts to projections of what would have happened that were made prior to the enactment of the legislation, as actual outcomes will differ from these projections for numerous reasons beyond the effects of the legislation itself, including both other legislation and other unrelated economic developments.

In addition to the challenge of defining the counterfactual, there are additional conceptual and practical challenges in bringing this question to the data. For wages, the measure of primary interest is the amount of compensation per unit of work, but measuring this quantity requires measures of total compensation—not just cash wages—and measures of how much work is done. In addition, as compensation is not necessarily linear in the quantity of work, simply dividing compensation by measures of labor supply may not yield the appropriate answer if other changes in labor hours are occurring at the same time, as might be expected in a strengthening economy. Measuring compensation for highly paid workers can be even more complex.

A parallel set of challenges applies to measuring the return on investment. The preferred measure would be the current return per unit of capital in the United States. This is difficult to measure in a direct way. There are ambiguities in the measurement of capital and depreciation, for example, which create challenges for estimating returns.

Ultimately, when estimates for the national accounts are released, they will incorporate assumptions about many of these issues and offer a complete and internally consistent set of estimates. These will be of interest to many economists and policymakers looking at the effects of the legislation. At the same time, the national accounts will lack the richness of detail that will be required for many academic studies that seek to parse out the finer details of the causal impact of the legislation. Moreover, the national accounts are sorely lacking in distributional information about how the experience of people across the income distribution compares to aggregate economic growth, and would not on their own allow for estimates of changes in the wage rate at different points in the wage distribution.¹⁰

In evaluating the effects of the legislation on wage rates and investment returns, a few additional points are of note. First, the quantity of interest is the wage rate, not aggregate labor earnings. In other words, the incidence of corporate tax changes is not primarily about changes in the number of hours worked. Thus, increases in earnings driven by increases in total employment or increases in the number of hours worked do not get at the key issue. Similarly, changes in the composition of the workforce can confound estimates, as can issues relating to intermittent payments such as bonuses.

Second, many analyses of incidence focus on average wages, but distributional questions matter. Do wages increase robustly across the entire income distribution, or only at the top, or largely at the bottom? In assessing who benefits from the Tax Cuts and Jobs Act, it is not enough to know only the change in average wages for the entire population, it is necessary also to know changes in wages across the income distribution. Indeed, in most models in which wages increase as a result of corporate tax cuts, the aggregate gains are still largely concentrated among more highly paid workers.

Third, much of the information that will be available to estimate the return on investment, especially in the short run, will be strongly influenced by expectations of future profitability, actual profits in the past, and the value of retained earnings going forward—not current profitability. One case in point: If the market valuation of a company increases because a piece of legislation is enacted, then it reflects an increase in expected profits in all future years, not just an assessment of profits in the coming year. Similarly, if a company buys back outstanding shares of its own stock, it is distributing cash that is reflective not only of current returns but also of past returns. Moreover, the decision to do so reflects, in part, assessments about the value of that cash inside the firm in the future such as the value of additional capital investments. Increases in dividends and buybacks are thus noisy indicators of returns on investment.

What is the fiscal impact of the Tax Cuts and Jobs Act?

Effects on wage rates and the return on investment will determine who benefits from the corporate tax cuts. Effects on future federal budget deficits will determine how large the cost of the legislation will be in terms of the offsetting policies required to pay for the tax cuts.

No credible estimate suggests that the Tax Cuts and Jobs Act would pay for itself. But there was still a range of estimates of exactly how large an increase in the deficit would result from the legislation prior to its passage in December and more recently from the Congressional Budget Office.¹¹ The ultimate fiscal impact of the legislation is a question of critical importance, as higher budget deficits will confront policymakers with more limited choices in the future. Future fiscal adjustments will be required to the extent that deficits and debt exceed what they otherwise would have been, especially if revenue-raising corporate provisions of the new law scheduled to take effect in the future are delayed or repealed or the individual tax cuts are made permanent.¹²

High-frequency information on government deficits is available from the U.S. Treasury Department, and in various summary forms from other organizations, including the Congressional Budget Office. Interpreting that data, however, is still as difficult as interpreting wage rates and investment returns, as the level of realized deficits must be compared to the level that would have been realized absent the enactment of the legislation. Moreover, corporate tax receipts are not paid steadily throughout the year but rather are concentrated in four months, creating additional challenges for interpretation.

The discussion of wage rates and the return on investment above did not directly consider changes in economic growth, and likewise the discussion of rising federal budget deficits and debt does not directly consider changes in economic growth. This exclusion is reasonable because, as a good approximation, changes in growth induced by supply-side tax changes do not themselves deliver gains directly to the public. Economic growth results from additional hours of work and additional capital investments, but both the additional hours of work and the additional capital investment come at a cost. The benefits and costs of those changes in hours worked and capital investment are roughly equal in terms of their impact on the public.¹³ Instead, supply side-driven economic growth matters insofar as it affects the cost of the legislation. Higher growth will generate additional tax revenue that reduces the cost of the legislation relative to what it would have been, assuming economic activity was unchanged by the legislation.

There are, of course, economic relationships between changes in economic activity and changes in wage rates and the return on investment, but there is no formulaic rule that applies across all economic models. The same growth impact can be consistent with very different changes in wage rates and returns, and different amounts of growth can be consistent with the same changes. For this reason, while economic growth was a central focus of the proponents’ case for the legislation, it is not in and of itself a critical issue for assessing the effects of the legislation on the broader public. Growth alone is not sufficient to deliver the promised benefits of the legislation for workers. And the corporate tax could be highly incident on labor even if corporate tax cuts have a negligible impact on growth. In addition, relying on economic growth as an outcome necessarily ignores distributional considerations entirely, both in terms of differences between high- and low-income families and between workers and shareholders. A focus on wage rates and deficits instead provides the relevant information for assessing the impact of the law on economic well-being and naturally allows for a consideration of distributional implications.

What other effects might the Tax Cuts and Jobs Act have?

The Tax Cuts and Jobs Act made far-reaching changes to the tax system, and many of these changes will have economic consequences. For instance, changes in the financial incentives to report income in the United States rather than in foreign countries for tax purposes may change where firms report their earnings, how much they pay in taxes, and may even create challenges for the accurate measurement of U.S. output in the national accounts.

These effects will be informative about how the economy works and will be a rich source of study for economists for years to come. They also will be highly relevant for more narrowly defined questions. Assessing the role of measurement and reality in national accounts, for example, is an important question in its own right. Similarly, changes in the mix of debt and equity used by corporations to finance their activities may have interesting economic consequences of their own.

Yet for purposes of evaluating the overall effects of the legislation on the well-being of U.S. families, these questions are not of primary importance. Instead, for that purpose, the key ingredients for an evaluation of the legislation are changes in wage rates and investment returns, as well as the net fiscal impact.

Measuring the economic effects of policy changes

Prior to the enactment of a piece of legislation, analysts use the findings of prior theoretical and empirical research to predict the effects it will have if enacted. These evaluations may take the form of constructing a mathematical model of the economy and using that model to predict how the economy will respond to a change in policy. The assessments may also take the form of applying prior empirical findings on how policies affect the economy to the proposed change in policy, generally with modifications to reflect differences between the policy change studied in the past and the proposed policy change.

After legislation is enacted, researchers then will study the effects that the legislation had on the economy. These methods used in these studies will often be quite different from the methods used in the pre-enactment simulations and focus on more narrowly defined empirical questions about specific provisions of the law. Researchers may study how the changes in cost-recovery provisions affected investment, or how the changes in state and local tax deduction affected the behavior of state governments, or other similar questions.

While economists use many different methods to examine the effects of policy changes, a common idea across such studies is to try to identify people, firms, governments, or other actors who were relatively more affected by a policy change and those who were relatively less affected but who are otherwise similar, and then compare their subsequent behavior to learn something about the policy. As with prior pieces of major tax legislation such as the Economic Growth and Tax Relief Reconciliation Act of 2001, the Tax Reform Act of 1986, and the Economic Recovery Tax Act of 1981, economists will be publishing numerous studies of the Tax Cuts and Jobs Act in the coming years. These findings will inform the modeling of analysts in their attempts to evaluate and provide advice regarding future pieces of tax legislation.

The challenge of defining the counterfactual

A major challenge in these studies, as noted above, will be defining the appropriate counterfactual, or what would have happened absent enactment of the tax law. A steadily improving labor market, for example, would be expected to deliver wage gains regardless of changes in tax policy. Nominal wage gains excluding benefits (increases in the wage rate excluding benefits before accounting for inflation) are strongly correlated with labor market tightness, as measured by the employment-to-population ratio for people ages 25 to 54.¹⁴ With continued improvements in the labor market, we would expect faster wage gains.¹⁵ (See Figure 2.)

Figure 2

In its June 2017 economic forecast, the last forecast released prior to enactment of the Tax Cuts and Jobs Act, the Congressional Budget Office projected increases in the wage rate (excluding benefits) of 3.2 percent in 2018 and 3.4 percent in 2019, consistent with a tighter labor market.¹⁶ If the U.S. labor market would have continued to strengthen absent the enactment of the Tax Cuts and Jobs Act, as seems likely, then these estimates may even understate the wage increases that would have occurred. In the late 1990s, when the employment-to-population ratio reached its highest levels ever recorded, wage growth also reached high levels.¹⁷

What can we say about the economic effects of the Tax Cuts and Jobs Act today?

The Tax Cuts and Jobs Act made major changes to the U.S. tax system, including a substantial corporate tax cut. Yet the results of academic studies of the legislation will only be available with a substantial lag. Effects can only be studied after they occur. Thus, it will take time before even the short-run effects can be studied. In addition, the research process itself takes substantial time. Even the earliest studies will likely not appear until years after the legislation has been enacted. Prior to the completion of these studies, policymakers and economists will be left to sift through much more limited information and engage in more speculative analysis using more readily available economic data. With that caveat in mind, this issue brief closes with an assessment of what we can say about the incidence of the corporate tax cut at this time.

First, who is benefitting from the corporate tax cut today? At present, primarily shareholders. There has been substantial discussion of potential bonuses and wage gains from the law, but it is important to scale these appropriately. An increase in wage rates of about 1 percent relative to wage rates that would have prevailed absent the law would be required to shift the benefits of the corporate rate cut from shareholders to workers. An increase on that scale would amount to about $100 billion in 2018. Tallies of wage gains, bonuses, and other forms of increased compensation tend to fall under $10 billion.¹⁸ Even taking these tallies at face value, they still suggest that at present, the gains are accruing predominantly to shareholders.

The absence of an increase in wages in the short run is not surprising. Most economists expected the corporate tax cuts to deliver windfall gains to shareholders. Yet even if it is not surprising that these tax cuts have delivered such gains to shareholders, that windfall remains the short-run story. Will the distribution of benefits from the corporate tax cuts change in the longer run? The long run has yet to occur, of course, so a direct examination is not yet possible. The best estimates of the long-run impact of the legislation today are informed primarily by the research that was available prior to enactment of the Tax Cuts and Jobs Act and that informed evaluations of its likely effects then. That research suggests that probably only a small portion of these corporate tax cuts will be shifted to workers in the long run, and most of the gains that are shifted to workers will accrue to more highly paid workers.¹⁹

Are there other inferences that can be made based on the experience to date? There is some suggestive evidence that share buybacks and dividends have increased relative to the counterfactual that would have occurred absent the law.²⁰ This finding is certainly consistent with the observation that a substantial portion of the benefits of the corporate tax cuts in present value will accrue to shareholders. Yet it may also raise concerns about the longer-run consequences of the law. The channel by which investment returns decline is that firms increase investment in response to the change in the tax law, and these higher investment levels reduce returns. If firms that receive large tax cuts are distributing cash to shareholders, then it indicates those firms do not see a need to retain the cash to engage in productive investments. Some firms may well increase their investment levels by more than average, but if large profitable firms are not sharply increasing their investment levels as a result of the law, then that raises concerns about not only the cost effectiveness of corporate rate cuts as a means of spurring more investment, but also how large any aggregate increase in corporate investment in the economy might be.

Conclusion

Public policies should be evaluated based on their impact on the well-being of the public. In the case of changes in tax law, that means the two questions of primary interest are about tax incidence (who bears the burden of a change in taxes) and fiscal impact (what the change in tax law means for the government budget). The Tax Cuts and Jobs Act included large corporate tax cuts that proponents claim will primarily or entirely benefit workers. The mechanism by which this shift would occur—if it does—is an increase in wage rates and a decline in the return on investment. Thus, in evaluating the Tax Cuts and Jobs Act, the first issue is whether this shift occurs. Do wage rates rise and investment returns fall sufficiently to negate the value of the corporate tax cuts to shareholders?

Every month in which these changes do not occur is a month in which the corporate tax cuts provided by the Tax Cuts and Jobs Act redound primarily to the benefit of business owners, not workers. These changes certainly have not occurred yet. Will they occur in the future? That remains to be determined.

Prior research, however, suggests only a partial shift to workers in the medium run and potentially negative effects in the long run for workers from higher U.S. budget deficits and federal debt if revenue-raising corporate provisions of the new law scheduled to take effect in the future are delayed or repealed or the individual tax cuts are made permanent. Moreover, even to the extent workers do benefit from the tax cuts, it is important to consider whether the benefits accrue equitably across the entire working population or primarily to more highly compensated workers.

In addition to the question of who benefits from the corporate tax cuts directly, the second issue is how large the fiscal costs of the legislation will be. Higher federal budget deficits and debt will require offsetting fiscal policies in the future, which means any assessment of gains from deficit-financed tax cuts must also reflect the costs they impose on the public in the future.