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.