Is Tax Reform Already Working?

To read the press releases, you might think the GOP’s new tax reform law is already a smash success.

The legislation, which permanently slashed corporate tax rates from 35 percent down to 21 percent, was only signed into law last month. But more than 100 companies have already indicated that they will make big moves to benefit workers and the economy—including raising wages, handing out bonuses, granting 401(k) increases, and committing to increased capital investment—while citing the law’s reduction in the corporate income tax rate as at least part of the reason.

American for Tax Reform published an impressive list of the companies who have made such announcements so far, with quotes linking their action to the tax bill. Walmart increased its base wage for all hourly employees from $10 to $11 and granted $1,000 bonuses. Aflac Insurance is extending parental leave, increasing its 401(k) match from 50 percent to 100 percent on the first 4 percent of compensation, and making one-time $500 contributions to every employee’s 401(k). That amounts to a $250 million increase in overall U.S. investment.

But it’s not clear how many of these moves would have happened anyway, even if tax reform had never passed. The recent burst of activity isn’t at all in line with the standard economic theory of how reductions in marginal federal business tax rates affect workers’ compensation. Economists usually argue that lowering marginal tax rates on investment gives companies an incentive to earn more taxable income leading them to invest in other businesses and the expansion of their factories. This in turn raises workers’ productivity, and ultimately leads to higher wages.

In other words, it takes time for companies to invest new capital, and reap the benefits of their investment.

This is clearly not what happened here, however, since many of the bonuses were announced after the House and the Senate passed the tax bill but before the president even signed it.

So what’s really going on?

I asked tax expert Scott Greenberg at the Tax Foundation how he explains the discrepancy. He said that “an alternate theory may be needed to explain the recent bonuses and pay increases.”

According to him, “One such theory, which has been suggested by Kevin Hassett, is that workers may have some ability to bargain for a share of the windfall from a business tax cut.” He isn’t sure how to evaluate yet whether that theory is correct, but he acknowledges that “it is true that some of the companies providing bonuses and wage increases have done so after demands by labor unions.”

Greenberg also offered another, more cynical theory. “Companies may have been planning on raising labor compensation anyway, due to increasingly tight labor market, and chose to attribute bonuses and wage increases to the tax bill, as part of an effort to build public goodwill for the legislation.” With Moody’s estimating that the unemployment rate will drop to 3.5 percent by the end of the year, the raises probably indicate a tighter labor market, and employers taking steps to retain their employees.

If this theory is correct, it is a brilliant public relations move from companies who for years have been labeled greedy bastards who always keep all their profits and will keep the benefits from the tax cuts all to themselves while leaving their employees out to dry. But it’s not exactly a sign that the tax law is an instant hit.

Now, this could play out in multiple ways. On one hand, based on the commitment made by many companies on the ATR list to increase their capital expenses significantly in 2018, more wage increases could be coming as the standard theory predicts. It will take some time to materialize, but it will happen.

On the other hand, the narrative that the bonus frenzy is a direct result of successful tax reform legislation could backfire. For one thing, Americans and employees may incorrectly expect for it to happen year after year. And while tax reform will indeed grow wages over time, it will never be as visible and marketable as the rollout of these announcements at the end of last year. When that doesn’t happen it could be used as evidence that tax reform is a failure.

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