In the immediate aftermath of the passing of the Trump tax reform, the ‘Tax Cuts and Jobs Act’, in December 2017, headlines told of companies bestowing pay increases and bonuses on their workers. Walmart, AT&T and American Airlines were among more than 400 companies who announced pay rises to a total of more than 1 million employees. Donald Trump was of course quick to claim credit, whereas the anti-Trump media claimed a tight labour market was the more likely cause. Who is right? Could tax cuts lead to pay rises?
A profit maximising business will hire workers as long as the marginal revenue generated from hiring an additional worker is lower than the cost of labour (the wage). Should the business face higher costs of other factors used in production (imaging a car factory facing rising steel prices) and be unable to pass this on to the consumer in form of higher prices on the end product, the marginal revenue will drop and the optimal work force will be smaller – the company will have to lay off workers – or alternatively convince their workers to accept a pay cut. From the point of view of the business owner, tax is like any other expense. It lowers the revenue and therefor lowers the marginal return on capital and labour. A company that faces taxation will have a smaller optimal workforce and/or pay lower wages.
That is obviously only part of the story. Money raised via taxation does not disappear and is not necessarily wasted. Some of it is indeed used to build roads. In absence of taxation, the business would have to pay someone to build and maintain a road network (it would not, as the left would have you believe, have to hire donkeys to carry the finished goods over the vast countryside because there wouldn’t be any roads in the absence of government). The service of looking after the roads has been assumed by the government and businesses are left with higher revenues and can hire more workers and pay higher wages when tax revenues are spent on such useful services. Of course, without a price mechanism, government has difficulties determining what is a sensible road to build and what is not. Political considerations takes precedence over economic calculation – that is why road building, like all other investment, is better left to the market where prices of production inputs and the finished product guides optimal resource allocation. But that is another discussion.
Taxation, then, will lower wages if the services a business gets from the government in return from paying taxes is worth less than the value of the tax bill.
While services such as roads, security (police), an educated work force, airports etc. has real value, much government spending, from many welfare programmes to nuclear weapons, studies of gambling habits amongst monkeys and how often angry people stab voodoo dolls, the ubiquitous pork barrel spending and the spending wasted on massive government bureaucracy has no benefit to business and their bottom line. The cost of much regulation is obviously downright detrimental to business, though much regulation is designed to act to lower competition and will increase revenues and pay (occupational licensing is an obvious example of where business has skilfully worked with government to enact regulation that hinders competition and allows for high returns and high wages).
The question of whether wages respond to tax cuts is therefore easy to answer: all else equal (that is if the services the state offers to, and burdens it places on, the business remains unchanged), tax cuts increases revenues and facilitates higher wages. The Trump tax cuts did come unaccompanied by any changes in services or regulation and the wage increases were therefore an expected outcome.
The Trump tax cuts obviously did more than lower the tax take. As it is not matched by equivalent spending cuts, government debt will increase. Down the line the detrimental effects of increased government debt could very well outweigh the positive effects business and workers presently enjoy. But so far, Trump is right when he claims the credit for the pay increases.