How Plumber Joe gains from US tax cuts
Reducing the US corporate tax rate and the taxes applied to offshore profits earned by US corporations has had unintended consequences. Some leading companies have immediately converted lower taxes into bonuses for their employees. These reactions are proving very helpful to the political ambitions of the tax reformers and damaging to the opponents of the tax reforms.
These immediate reactions to lower tax rates will not be the last or the most important influence of lower income tax rates. Lower tax rates will have improved the prospective returns on the capital invested by US companies. More than buy back shares or pay bonuses or dividends a company may wish to invest more in plant and equipment.
This seems very likely judging by the reactions of CEOs. The additional capacity will enable these firms to produce more. To sell more they may well have to reduce prices or improve the other terms on which they supply their customers. The benefits of lower tax rates will thus also go to their customers in the form of lower prices, better quality or better service, to attract more custom. And workers will benefit as the firms attempt to hire more of them and improve employment benefits to do so.
In the long run the benefits of a higher after-tax return on shareholder capital will tend to be competed away with increased supplies and lower prices or improved quality, as firms accept a lower pretax return. Higher income tax rates similarly lead to higher prices or lesser quality and lower employment benefits as investment and hiring activity respond negatively to the requirement to achieve higher required returns adjusted for risk before taxes.
The required (after-tax) returns on capital clearly drive the production and employment decisions of firms and hence prices and employment benefits. And so tax rates find their way into the prices charged for goods and services.
The benefits and medical or pension contributions that employers provide for their workers, other than take-home pay, will clearly influence the supply of workers, skilled and unskilled, available to a firm. The better the benefits, the greater the potential supply of job applicants and the lower the rate at which workers may quit for other jobs.
Increased supplies of workers will allow a firm to offer less take-home pay and still attract the workers it wishes to hire. And with the help of a lower cash wage bill a firm can better compete for custom with better prices.
Employees therefore will be paying for the benefits provided by the firms they work for in the form of a sacrifice of cash taken home. There are, after all, no free lunch canteens or Google campuses. Shareholders may not be paying for them — employees may well be doing so. And should the employment benefits in kind rather than cash enjoy much lower tax rates, as they mostly do, other taxes and taxpayers will have to make up for the lost revenue. The costs of a superior working environment are written off taxable income.
A flat expenditure tax rate is likely to mean more production and wealth creation and consumption as the disincentive effects of taxing extra income fall away. Helping the poor – redistributing what has been produced by the economy in their favour — is best done by well-targeted government expenditure, not the tax system.
Economic policy should avoid appearing to redistribute income through complicated taxes of one kind or another (which find their way into prices and will be gamed by the firms directly affected) and will not redistribute income as intended. Rather tax what is taken out of the economy — as consumption — than the income generated by the goods and services produced for it.