Corporate Tax Cuts Increase Income Inequality

North Star would like to thank Professor Louis Johnston of the College of Saint Benedict/Saint John’s University for critiquing earlier drafts of this article.

 

Conservatives typically argue that the benefit of corporate tax cuts will trickle down to workers in the form of higher wages. New research published this month indicate that workers do not benefit from state corporate tax cuts, at least in the short-term. The benefit of these tax cuts, rather, accrue to higher income households, with the very highest income households (e.g., the top 0.01%) enjoying the greatest benefit.

The debate over the impact of corporate tax cuts on economic growth and income inequality has intensified since the passage of the so-called “Tax Cuts and Jobs Act” (TCJA) by Congress late last year. Despite claims by business groups that TCJA tax cuts have translated into big pay increases for workers, the Economic Policy Institute makes a powerful case that such pay hikes are commonplace in a tight labor market in which businesses must compete for workers and “that there is absolutely no economic evidence” to believe claims of TCJA-driven pay hikes. This conclusion is consistent with a recent North Star analysis, which shows that the pay hikes attributed to the TCJA amount to only a tiny fraction of the TCJA tax breaks bestowed on businesses.

In a recent paper published by the National Bureau of Economic Research (NBER), Nallareddy, Rouen, and Suárez Serrato (2018) shift the discussion to state-level corporate tax cuts. The paper examines changes in income concentration from 1980 to 2010. During this period, income inequality steadily increased, interrupted only temporarily by recessions.* For example, 10% of U.S. income went to the top 1% of households by income in 1980; by 2010, this had nearly doubled to just under 20%.

Higher income households—those within the top fraction of the top 1%—enjoyed even more rapid income growth during this period. For example, the fraction of total income accruing to the top 0.01% approximately tripled over this period, from just over 1% of all U.S. income in 1980 to just under 5% in 2010. The degree of income inequality in Minnesota—especially within the top fraction of the top 1%—is similarly striking, as documented in a 2017 North Star article.

The NBER paper focuses on the extent to which growth in income inequality during this thirty-year span was driven by state corporate income tax reductions. Using IRS Statistics of Income (SOI) supplemented by data from other sources, the paper concludes that state corporate tax reductions account for 12.4% of the growth in income concentration over this period.

The effect of state corporate tax reductions is a particularly potent driver of income concentration at the highest income levels. For example, the paper finds that a state corporate tax cut of one percentage point increases the income share of the top 10% of households by 0.67 percentage points, while increasing the income share of the top 1% by 0.59 percentage points and of the top 0.01% by 0.23 percentage points. In other words, about 87% (≈0.59/0.67) of the increased income inequality in the top 10% is concentrated in the top 1%, while 34% (≈0.23/0.67) is concentrated in the top 0.01%.

A hypothetical example is useful in illustrating the extraordinary extent to which the income increase resulting from state corporate tax cuts is concentrated at the highest levels of the income spectrum. Assuming a $1 million aggregate income increase resulting from a state corporate tax cut distributed among the top 10% and assuming 100,000 households within this group, the average income increase for the top 0.01% would be $3,400, based on the NBER research. This contrasts to just $53.54 for the top 1% excluding the top 0.01% and $1.44 for the remainder of the top 10% excluding the top 1%.

Meanwhile, the average income increase among the bottom 90% of households resulting from a state corporate tax cut in this hypothetical example would be virtually nothing in the short run. The gains to the top 10% (and especially the top 0.01%) are immediate, while the benefits, if any, to the remaining 90% will trickle down over a long period of time.

Using an alternative approach, the paper finds that a one percentage point state corporate tax cut increases the income share of the top 1% by 1.52 percentage points. Even after controlling for the effects of various “confounding” factors, the observed relationships are statistically significant, thus “providing robust evidence that state-level corporate tax cuts result in increased income inequality.” The paper concludes that “While those earning under $200,000 per year have no significant change in their income following a tax cut, AGI [Adjusted Gross Income] increases by 3.5% for those that earn more than $200,000.”†

The NBER paper focuses on the short-term impact of state corporate tax cuts. The paper observes that it is possible that benefits may accrue to lower-income households over the longer term. However, the benefits to business owners are “front-loaded,” while benefits to workers are “back-loaded” and occur only after incurring increased income inequality, if at all.

The paper concludes by noting that attempts to stimulate state economic growth through corporate tax cuts depend on increases in income inequality to generate additional economic activity. In contrast, “other approaches such as government spending at the local level or tax cuts to low-income earners may stimulate the economy without increasing inequality.”

In short, state corporate tax cuts are not an efficient way and certainly not the quickest way to stimulate broadly distributed growth in the state economy and halt the tide of rising income inequality. Policies that put dollars directly into the pockets of low- and middle-income Minnesotans—either through tax cuts or through public investment—will not only counteract the trend of growing income inequality, but will stimulate economic growth by enhancing the purchasing power of working households.

 

*During a recession, investment income typically plummets more than wage and salary income. Because investment income is more heavily concentrated in high-income households, the income of these households typically fall more rapidly during a recession. However, the incomes of high-income households tend to increase more rapidly when the economy is not in recession. The temporary leveling effect of recessions has not been sufficient to halt the longer term trend toward rising income inequality.

According to the NBER paper, the effect of a corporate tax reduction is to reduce the wage income of high income households (i.e., above $200,000), as these households “shift their taxable income from wages to capital income in order to take advantage of lower tax rates.” The resulting increase in capital income is more than sufficient to offset the decrease in wage income, thereby resulting in the 3.5% AGI increase experienced by these households. This portion of the NBER analysis is based on IRS SOI; the highest income group examined in the IRS SOI are households above $200,000.