The Corner

Politics & Policy

Tax Cuts and Bonuses

Two articles in the Wall Street Journal about the wave of bonuses and higher pay that seem to be triggered by the recent tax reform bill caught my eyes this morning.

I wrote about this on Friday over at Reason, arguing that the impressive number of companies’ announcements, are great for the several million Americans who will receive bonuses, pay raises and higher 401k contributions from their employers, but don’t quite fit with the standard economic theory of why and how reductions in corporate taxes trigger higher wages over time.

As the theory goes:

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.

I quote the Tax Foundation’s Scott Greenberg who offered two alternative theories about the bonuses and pay raises. 

“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.

The second theory finds some support in these two pieces in the Journal. First:

With the unemployment rate low and unfilled job openings high, losing workers to a competitor can be more costly than handing out bonuses. Indeed, the concentration of tax-cut bonuses and raises in certain industries suggests one reason companies handed them out was that they didn’t want their employees to view them as stingier than competitors. Several airlines and dozens of banks got on the bandwagon.

So the real news in the flurry of bonuses and raises might be that the job market has tightened to the point where wage growth, which has long been stagnant, is beginning to pick up. As that occurs, more companies will need to hand over more money to employees. The tax cut will make it easier, but they will still have to pay.

Second:

In terms of costs, though, wage pressures may be more substantial than bonuses in the long run. They aren’t so much a product of tax reform as a necessity of an increasingly tight market for unskilled labor. Despite a supposed retail apocalypse, demand for retail workers is high. As of November 2017, there were 711,000 such job openings—the highest number since the data was first collected in 2000, according to the National Retail Federation.

“We’ve been waiting for a wage increase as the unemployment rate has come down,” says Jack Kleinhenz, chief economist of the National Retail Federation. “It’s probably just starting to percolate up.”

A tight labor market is good news for employees because companies have to compete to retain them and are willing to jack up wages to do so. Both articles acknowledge that the tax cuts make the cost of bonuses and pay raises easier to digest, so the tax reforms and a year’s anticipation for such changes have played some role in this. The timing, however, was a brilliant move from the companies who are always taking a beating for being greedy and never sharing their benefits with employees.

In my opinion, the more important news is that, as companies were announcing bonuses and wage hike, many of them also made commitments to jack up their capital expenses significantly. Indeed, as we have seen in recent days, capital expenses are  seriously heating up and we should expect this trend to continue with positive results for the economy and workers.

 

 

 

 

 

Veronique de Rugy — Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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