Cutting corporate rates vs. boosting the EITC

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.


Comments for this post are closed