Cutting corporate rates vs. boosting the EITC

by on October 17, 2017 at 3:08 pm in Current Affairs, Economics, Uncategorized | Permalink

If the federal government boosts the Earned Income Tax Credit, or for that matter just lowers tax rates on lower-income workers, firms have an incentive to hire more labor (and also an incentive to expand hours for individual workers).  Those effects are large, for a fixed EITC boost, to the extent the demand for labor is elastic.

Note that if EITC boosts only labor demand, without the scale of business expanding as well, the marginal product of labor will fall somewhat, undoing some of the beneficial net wage effects.  On the other hand, if the scale of business expands, some of the benefit is reaped by capital and natural resource owners as well.

OK, now say we cut corporate tax rates.  Companies do more of…something, maybe we’re not quite sure what.  Labor is targeted less directly, though in “simple stupid” theory we treat labor as the main marginal cost.  So if corporate rates don’t have a large impact on activity overall, they might have a disproportionate impact on labor demand within the changes that do happen.  For instance, if plant size stays the same, you hire more labor to distribute more product.

As with EITC, to the extent the elasticity of demand for labor is small, the quantity of labor hired won’t go up much, nor will wages.

Maybe a corporate rate cut will induce an increase in overall scale and activity, and thus the hiring of more capital and resources, in addition to labor.  That may mean a smaller immediate boost to labor returns, but in the longer run labor is combined with more capital and resources and thus may maintain a higher marginal product.

EITC does have the advantage of being more directly targeted to labor.  But in the world-states where that targeting matters, labor ends up surrounded by not enough capital.  Cutting the corporate tax rate is more likely to favor scenarios where the demand for labor goes up, capital thickens around labor, and labor remains relatively non-commoditized.  This may go especially well for workers when there are increasing returns to scale.

The economics of these cases are fairly similar, albeit with the afore-mentioned difference in terms of targeting.  That difference may or may not favor EITC.  In any case, for me it is strange if people favor an EITC boost but are skeptical about cuts in the corporate rate.  Both require an elastic demand for labor, if they are to be effective in raising wages.

Egalitarians tend to think the more “naked,” targeted subsidy to labor will be more effective than removing disincentives to production, but that doesn’t really follow.

Note also that cutting corporate probably lowers avoidance/fraud, whereas boosting the EITC would increase tax fraud.

1 JWatts October 17, 2017 at 3:13 pm

Perhaps, a little of both combined with a tightening of deductions to keep the tax revenue from dropping.

2 GoneWithTheWind October 17, 2017 at 4:44 pm

End the EITC. It is perhaps the stupidest form of free stuff every created. More than half of it goes to people who are not eligible, illegal aliens or to crime syndicates. Most people who get it use it to buy a car they cannot afford and won’t insure and six months later after not making any payments it get’s repossessed. The rest just spend it on drugs and alcohol like most welfare cash/benefits.

3 JWatts October 17, 2017 at 5:26 pm

The EITC is far better than welfare, because you only are eligible if you are working and it doesn’t price labor out of market wages and drive up unemployment like a minimum wage does.

4 Art Deco October 17, 2017 at 6:23 pm

I’m the Veruca Salt of this blog.

5 GoneWithTheWInd October 17, 2017 at 8:23 pm

In theory it is better. Or more correctly as it was described to the citizens/voters it was better. But today it is thousands of dollars for free, no proof of qualifying (hence half is sent to illegal aliens and cheats), and pressure to increase the amount every year. It is also paid without regard to how much money the recipient gets from other sources of welfare.

What would be better is a overall limit on how much welfare of all forms someone could receive> I would suggest not to exceed the minimum wage. That taxes are paid on it just as I pay taxes on my income.

What would be best is “workfare” and no welfare at all. At state and local levels jobs for anyone in need, minimum wage and taxed. .

6 JWatts October 18, 2017 at 8:42 am

Illegal aliens certainly benefit from minimum wage laws. Furthermore, you need a SSN to qualify for EITC. I’m sure there are illegal aliens who have illegally obtained SSN’s. However, the root problem is people committing crimes, not the EITC itself.

7 GoneWithTheWind October 18, 2017 at 11:03 am

“However, the root problem is people committing crimes, not the EITC itself.”

The root problem is the IRS failure to find and eliminate the fraud. This should be one of the easiest crimes in the world to investigate and punish. The “criminal” in order to commit the crime must send you their personal information including their name and address. As for the SSN issue; again using a fake or stolen SSN is the easiest crime to identify. Every SSN has a wealth of personal data associated with it and the government holds all the data. When a person uses the SSN of a dead person or someone across the country the Dept of SS knows it. The employer sends in the withheld taxes with the SSN’s of their employees. A simple computer algorithm could pick out these inconsistencies immediately. So the root problem is our government failing to act to uncover these crimes.

8 JonFraz October 18, 2017 at 1:57 pm

There is no evidence behind your claims.

9 GoneWithTheWind October 18, 2017 at 8:26 pm

There are none so blind as those who will not see.

10 GoneWithTheWInd October 17, 2017 at 8:25 pm

You obviously have a very strange definition of “subsidize”. But I say let’s not subsidize anything.

11 Dude October 17, 2017 at 11:19 pm

When you say absolutes like “let’s not subsidize anything”, some people might flip the bozo bit on you b/c it seems more religious than economic. Not that I agree or disagree with you in this particular instance.

12 Boonton October 17, 2017 at 9:18 pm

You need a SSI number to get the EITC, not just a taxpayer identification number which is what an illegal alien could get (as well as legal ones).

Most people who get it use it to buy a car they cannot afford and won’t insure and six months later after not making any payments it get’s repossessed.

Perhaps anyone who makes less than $50K per year can have their paychecks automatically deposited in some giant corporation run by one of Trump’s trash family. For a ‘fair management fee’, the ‘customers’ could have the corporation decide how their money is properly spent rather than doing it themselves.

13 GoneWithTheWind October 18, 2017 at 11:07 am

You miss the point. I don’t give a fig how they spend “their” money. It is how they spend “our” money that pisses me off. IF they “need” welfare because they can’t live without it then give them help not money. And most certainly don’t give them taxpayers money. It is immoral to take money from the productive under threat and give it to the unproductive so they can piss it away on frivolous things.

14 IVV October 18, 2017 at 1:21 pm

On frivolous things made and sold by the productive? Or are the unproductive making and selling the frivolous things as well?

15 JonFraz October 18, 2017 at 1:58 pm

It’s not “your” money– it’s theirs.

16 GoneWithTheWind October 18, 2017 at 8:24 pm

It’s “our” money until the tax man cometh and taketh away. It is a lie that they must do this because the “poor” cannot fed, house and clothe themselves and when they buy a car instead of food, lodging or clothes with money taken from honest people THEN that is frivilous.

17 spencer October 17, 2017 at 3:23 pm

note that labor’s share of output has a negative correlation with the corporate tax rate.

18 Anonymous October 17, 2017 at 3:24 pm

I don’t want a tax cut (good old fiscal conservative here) so I don’t have a dog in this fight.

From that perspective, it looks like people saying “well, if you are going to do a tax cut, it should go to my people.”

19 Joe October 17, 2017 at 4:15 pm

/\ “I don’t want a tax cut (good old fiscal conservative here)…”

I absolutely want tax cuts everywhere & oppose all tax hikes anywhere (good old libertarian here)

And it is not within the function nor authority of American government politicians (and their economist seers) to manipulate the private economy via taxes.

20 Anonymous October 17, 2017 at 4:22 pm

Wanting tax cuts without balanced spending cuts is a hunchbacked libertarianism at best, and possibly not even that.

This whole cycle may be about greed, and a national agreement to discard responsibility.

21 GoneWithTheWind October 19, 2017 at 11:14 am

In all fairness most conservatives want tax cuts AND budget cuts. In fact I am in favor of a balanced budget amendment requiring the government to live within it’s budget.

22 ttt October 17, 2017 at 7:07 pm

Uh, oh Joe, i just heard the bell. you are going to be late for class

23 Joan October 17, 2017 at 3:32 pm

Under the proposed plan most of domestic business profits will be reported as pass throughs which Trump wants the max rate lowered to 25%. Talking about the corporate tax is a diversion

24 other derek October 17, 2017 at 3:38 pm

Can someone explain why an EITC increase result in increased demand for labor from companies? Wouldn’t an EITC change affect a worker’s demand for a job rather than an employer’s demand for a worker?

25 Karl Smith October 17, 2017 at 3:57 pm

It’s not that it results in an increase in labor demand from firms. Its that it increases labor supply from workers. The net effect of the increase in labor supply, however, demands on the elasticity of labor demand. If the elasticity were low, that would firms don’t really want many more workers. So, when they see more workers clamoring for jobs, firms simply lower their wages. Or conversely stop offering raises.

In this case even though the EITC has gone to workers, it ends up benefiting firms who now don’t have to raise wages.

On the other hand, if labor demand is elastic then firms will eagerly take up the new workers at the existing wage and the workers will keep more of the EITC increase.

26 Karl Smith October 17, 2017 at 4:00 pm

meant to say “The net effect of the increase in labor supply, however, depends on the elasticity of labor demand”

27 other derek October 17, 2017 at 4:05 pm

Okay, this is how I think of it, too. I was wondering if I was missing something given TC’s discussion of “labor demand”, which I interpreted as “demand for labor” instead of “demand for labor versus leisure from workers”.

28 Justin October 17, 2017 at 4:16 pm

This makes sense, perhaps Tyler should have phrased things differently. He speaks of increased demand when it’s really just a higher quantity of labor supplied at equilibrium, as well as phrases like “firms have an incentive to hire more labor” which seem backward for what we’re discussing, without first mentioning that the increased incentive is due to an increased supply of labor and not that labor has become relatively cheaper to hire.

29 JWatts October 17, 2017 at 5:29 pm

Tyler’s whole post is unusually poorly worded for his normal writing style. So, I’m guessing there’s a Straussian take away from this post.

30 BC October 17, 2017 at 8:14 pm

Yes, the wording of boosting “labor demand” instead of boosting labor supply and increasing quantity of labor demanded is poor, but I think Tyler was trying to highlight the similarity of economic incidence between EITC and corporate tax. Cutting corporate tax increases labor demand quantity by boosting labor demand while increasing EITC increases labor demand quantity by boosting labor supply.

31 BC October 17, 2017 at 8:59 pm

Also, I think one of Tyler’s points is that, although EITC is targeted towards labor, that same targeting causes firms to spend relatively more on labor than capital compared to a corporate tax cut and, in turn, that may mean in the longer run that the corporate tax cut can result in a higher marginal product of labor. That may be what Tyler means by EITC “boost[ing] only labor demand” — firms spend more on labor but not capital.

32 JWatts October 18, 2017 at 8:45 am

My assumptions were similar to yours, but in good writing you clarify those points. You don’t state critical points in a vague and illusory manner. And Tyler is certainly aware of good writing practices. So,a good question is, Why did he state it that way? Obviously it’s to avoid being pinned down, but why is he worried about being pinned down on those points?

IE Straussian.

33 Floccina October 17, 2017 at 5:27 pm

That is my thought, but I do not understand why he rather did not say EITC will increase the supply of labor.

34 Grumpy October 17, 2017 at 8:26 pm

Have finally twigged to this Straussian business. TC will post whatever nonsense and his commenters will twist and turn themselves into pretzels to explain it.

35 carlospln October 17, 2017 at 9:39 pm

Because he can’t write clearly & insists on torturing his prose.

36 JWatts October 18, 2017 at 8:46 am

No Tyler clearly can write clearly. Sometimes he chooses not to. The Straussian aspect is why he chooses not to in some cases?

37 peri October 18, 2017 at 10:12 am

Thank you for asking that, other derek.

38 Verbal October 17, 2017 at 4:12 pm

If the intent is to give money to working people who need money, then the EITC is a far more direct approach.

Cutting the tax rates on business owners may or may not induce them to hire or increase wages. It will give them more money, and many of them would probably increase hiring and wages. But others wouldn’t. There’s some inefficiency there.

If you’re going to spend a billion dollars to help the working poor, why not just… help the working poor?

39 chuck martel October 17, 2017 at 4:34 pm

Why would anyone believe that if business owners have more money that they’ll hire more people or increase their wages? There was an article in the WSJ recently stating that auto firms were cutting back on advertising because car sales were down. Huh? Whatever happened to rational actors?

40 JWatts October 17, 2017 at 5:34 pm

“If the intent is to give money to working people who need money,”

Why would you think that would be the only intent? I suspect the intent is to increase the growth rate of the American economy by increasing business activity (through lower taxes) and increasing the labor market (through increasing the EITC, which incentivezes workers to work more).

41 chuck martel October 17, 2017 at 11:24 pm

The intent is for those who are in office to remain in office, as Robert Dole once explained.

42 JWatts October 18, 2017 at 8:48 am

Again, certainly that’s one intent, but hardly the only one. And frankly that’s the least important one to consider in this context.

43 The Other Jim October 17, 2017 at 4:14 pm

Hey look everyone – Ty continues to ignore the fact that reducing the rate will in fact CREATE MORE US COMPANIES!!!!

Either brand new ones, or foreign ones relocated.

That wouldn’t fit the narrative, of course. Stay the course, big guy.

44 Justin October 17, 2017 at 4:17 pm

“Maybe a corporate rate cut will induce an increase in overall scale and activity, and thus the hiring of more capital and resources”

Doesn’t seem like he ignored the scenario you mention.

45 rayward October 17, 2017 at 4:39 pm

What liberals don’t understand is that tax cuts are the successful policy. No, not what the tax cuts produce (higher or lower employment, higher or lower economic growth, financial and economic instability or stability), but the tax cuts themselves that are the successful policy. Cowen understands that, which is why the corporate income tax cut and the EITC are successful policies without regard to what they produce. Maybe this, maybe that, it’s all irrelevant.

46 Bill October 17, 2017 at 5:09 pm

Words to think about

“The tax cuts in 2001 (EGTRRA) reduced income tax rates, phased out and temporarily eliminated the estate tax, expanded the child credit, and made other changes. The 2003 tax cut (JGTRRA) reduced rates on dividends and capital gains. The impact on growth of these changes appears to have been negligible.”

“Based on analysis in Gale and Potter (2002) and Gale and Orszag (2005a), the 2001 tax cut raised the cost
of capital for investments in residential housing, sole proprietorships, and corporate structures because the higher de cits raised interest rates. By contrast, the cost of capital for corporate equipment fell slightly because the tax act also contained provisions for bonus depreciation that more than offset the rise in interest rates. It might also be thought that the 2003 tax cut would have more bene cial effects on investment, since it focused on dividend and capital gains tax cuts. But Desai and Goolsbee (2004) nd that the 2003 tax cuts had little impact on investment.”

From Brookings: https://www.brookings.edu/wp-content/uploads/2016/06/09_Effects_Income_Tax_Changes_Economic_Growth_Gale_Samwick.pdf

Maybe the tax cut is just about redistribution, and nothing else. So, maybe an EITC increase is a sop to the poor to offset cuts coming down the road later when, with the tax cuts and increased deficits, we cut the social safety net.

47 Richard Evans October 17, 2017 at 5:39 pm

I think you mean household “supply of labor” everywhere you say “demand for labor”.

48 Lewis October 17, 2017 at 6:18 pm

A significant share of capital income is due to rents from intellectual property for products that have low to zero marginal cost of production—like streaming Netflix movies or using Adobe illustrator software. While a cut in the corporate tax rate would expand incentives to come up with new IP, doesn’t it also uselessly transfer money to people who hold those existing patents? It’s not like Adobe is going to lower the price of Illustrator just because their tax rate is lower. Presumably the price is set to the profit-maximizing price now, and that will be the same profit-maximizing price after the cut, given the zero marginal cost of letting someone download the software.

Same goes for owners of scarce natural resources. It does incentivize them to cut a little more deeply into their stocks, but for all the stock that’s already profitable they’ll just make a lot more money for producing nothing additional. In fact, lots of natural resources are already locked into long-term leases at rents that were set under the old tax rates.

That’s why I don’t think it’s quite right to think of the Republicans as a “supply side” party. If they were really interested in the supply side, they would be targeting the supply of labor among the groups who are subject to dropping out of the labor force. For example, I read about some social security reforms that would remove some of the incentive to stop working by removing some penalty. I am sure disability insurance could be reformed also. The big kahuna is the high implicit marginal tax rates faced by low-income people with children, but those are presumably and complicated expensive to fix, so I don’t fault people too much for not taking a big interest in those.

Rather, I think the Republicans are pretty obviously a social justice party. They are sort of the right-wing counterpart to the Democratic Socialists of America, who view capital income as illegitimate and don’t fret too much about specific consequences of taxing or unionizing it all away. I think even if you explained in detail about labor elasticity of middle-class retirees, most Republicans just wouldn’t care, because their goal is simply to relieve the burden on America’s capital owners, whom they view as unfairly burdened. It is all about justice.

The biggest evidence I’ve seen of this is the enthusiasm for retroactive cuts. These are simply a transfer from what I can tell. In fact, if you wanted to do a supply-side corporate tax cut to really boost supply, what you would want to do is enact it several years in the future: since it takes a while to get new projects planned, the first year will probably not yield much new investment. Then you could take the money from the first year or so of delay and enact an even bigger tax cut in the future. But this is of no interest.

Likewise the crickets at the idea of repealing the Jones Act for puerto rico.

49 A Truth Seeker October 17, 2017 at 6:33 pm

End all welfare and give Americans their jobs back! Make China pay reparations for the jobs they took from Brazil and the United States with their disloyal competition.

50 No, really October 18, 2017 at 2:35 am

There’s something wrong with your brain.

51 joshua blumenkopf October 17, 2017 at 8:34 pm

Do corporations only hire low-wage labor? What about the managers,lawyers, engineers, etc.? The comparison should be between lowering corporate tax vs. lowering all earned income taxation including raising EITC.

52 KZ October 17, 2017 at 10:09 pm

In a world A where the tax rate on workers are lower, and another world B where corporate tax is lower, even if the effect on employment is exactly the same, isn’t it true that in world A the workers has lower tax burden, and in world B the corporate has lower burden? Then maybe the question should be about who should bare the cost of possibly stimulative policy.

53 Moo cow October 17, 2017 at 11:08 pm

Well, supposedly the corporate tax cut will result in wages going up by $4,000 a person!!! What is EITC?

54 JWatts October 18, 2017 at 8:50 am
55 Moo cow October 18, 2017 at 1:49 pm

Yay! Hahahahaaaaaahaha…

56 carlospln October 18, 2017 at 10:43 pm

“Maybe a corporate rate cut will induce an increase in overall scale and activity, and thus the hiring of more capital and resources, in addition to labor”

Your naivety is indeed touching.

But, hey, great framing-and Charles Koch approves!

57 Glenn Schafer October 20, 2017 at 8:44 am

EITC fraud is rampant here in Southern California. In Santa Anna the tax preparers have filled out the forms in advance. There is a huge cash economy here. The income reported is the amount that gives the filer the maximum EITC payment. Every self respecting participant in the cash economy knows how the system works and how to take advantage of it.

58 Baron Samedi October 21, 2017 at 2:14 am

Didn’t we try supply side economics before? Didn’t it already demonstrably fail to achieve what its advocates promised?

We want to have an effective tax rate that makes us globally competitive, but regardless of what you do to corporate taxes, labor will always be a marginal cost that executives will seek to minimize in order to maximize profits for shareholders. Many of the most profitable companies in the US are already sitting on mountains of cash that they could be reinvesting, and I don’t see any push to expand employment or much trickle down benefit to their laborers (unless they purchased some of those fancy suicide prevention nets to prevent more Foxconn workers from throwing themselves to their death to escape life in the factory and I just don’t know about it).

59 Craig November 2, 2017 at 7:36 am

Does this analysis change if there is skilled and unskilled labor, with EITC only subsidizing unskilled?

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