Tax cuts don’t always mean higher wages

Since President Trump signed the Tax Cuts and Jobs Act, the Administration has trumpeted the job creation aspects of the tax cuts. Opponents of the legislation have argued that the new tax law is the ultimate in trickledown economics and not much will trickle down to ordinary folks.

So who’s right? In this era of sensationalized news it is hard to make that determination.

After giving this matter some thought, I realized that there is historical precedent for corporate tax cuts which can be analyzed. Fortunately, most of the necessary data for the analysis is available at www. tradingeconomics.com. This website maintains a host of historical economic data for about forty nations. The data is a terrific source for an historical analysis.

The data suggests that when corporate taxes are cut, wage growth is most likely to occur in jurisdictions with relatively low labor costs.

Corporate tax cutting started in earnest in Ireland in 1996. Between 1996 and 2004, Ireland dropped its corporate tax rate from 40 percent to 12.5 percent. During that period, the Irish economy grew by an astounding 11 percent annually. The Irish unemployment rate dropped from 12 percent to 6 percent. Wages, adjusted for inflation, grew by 2 percent to 4 percent annually.

Irish labor costs were significantly lower than the prevailing wages in northern Europe. Low wages and low taxes attracted many multinational companies to Ireland.

In 2006, other countries, hoping to stimulate their economies, sought to emulate Ireland. In Europe, Great Britain and Denmark are prime examples. Elsewhere, Canada, China and South Korea hopped on the bandwagon.

Nations with cheap labor generally enjoyed economic results comparable to those of the Emerald Isle. China, in particular, experienced annual wage growth of nearly 12 percent. Its economy grew by nearly 9percent annually. Tax cuts likely played a role in this growth because low wages and low taxes encouraged many companies to move their manufacturing facilities there.

The rest of the countries experienced annual wage growth in the 1 percent to 2 percent range. Their current unemployment rates are typically about the same as they were in 2006. Because the global economy in 2006 and our current economy are in similar stages of the economic cycle, comparisons between the two are plausible.

Let’s compare the tax cutting nations with nations that left their corporate tax rates intact. The United States, Germany and France all maintained tax rates in the 29 percent to 35 percent range. Their annual wage growth since 2006 has been in the 2percent range. Each country’s current unemployment rate is comparable to what it was in 2006.

The cost of labor, relative to emerging markets, is high in these countries, as it is in the United Kingdom, Canada and Denmark. According to the trading economics website, the average labor costs in European countries and in America are about four to five times greater than Chinese labor costs. Therefore, cutting taxes in those countries simply did not provide the same bang for the buck to multinational corporations seeking to minimize costs.

Based on the historical results for Britain, Canada and Denmark, the chances of our recently enacted corporate tax reductions trickling down to workers are apparently not robust.

Clearly, the United States’ economy dwarfs these nations, but nevertheless there is no precedent for a nation with relatively high labor costs enjoying substantially increased levels of employment or wage growth after implementing corporate tax cuts.

There is another aspect to this issue that has not received much attention.

I recently spent some time with international tax specialists who are looking into whether the recent tax law changes make it cheaper to outsource operations to other jurisdictions.

Prior to enactment of the recent tax changes, US companies doing business abroad were subject to two layers of tax. First they were taxed in the foreign jurisdiction. Then they were taxed a second time by the US when the foreign profits were repatriated. (Repatriation means that the funds are moved from the foreign jurisdiction to the US.) Removing US tax on repatriated profits, which was designed to encourage repatriation, means that US companies can now manufacture abroad without paying US tax on future foreign earnings.

Many large multinational companies historically avoided this double tax by permanently investing their profits offshore. However, many smaller companies could not stay in business unless they repatriated their foreign earnings, so it was cheaper for them to operate in the US. Under the new tax law, these companies can now have their cake and eat it too. They can utilize cheap foreign labor without the historic US tax burden.

Based on my conversations, I understand that many smaller companies are now looking to expand their foreign footprint--which probably will not be good for the US labor pool.

I certainly hope that the Trump Administration is right and we will see continued growth in wages and employment, but I am somewhat skeptical that the tax cuts will work as promised.