Yes, Tax Cuts Really Are The Reason For Your Raise

Since Trump’s reduction of the corporate tax to 21%, workers across the country have been rejoicing. Companies like Wal-Mart, Apple, Bank of America, and many more have announced firm-wide bonuses and minimum wage raises. To most, the tax cuts appear to be a clear success. However, some commentators, such as Dr. Veronique de Rugy at Reason, are saying not so fast.

Dr. de Rugy claims that these announcements are not in line with economic theory. For wages to be affected by tax cuts takes an extended period of time. The newly freed revenue must be accumulated and invested into new capital equipment which boosts worker productivity and, consequently, their wages. Quite simply, Dr. de Rugy suggests that the tax cuts simply have not been in place long enough to be held directly responsible for these announcements, and she even ponders if they are nothing more than PR moves.

In truth, these bonuses and raises are perfectly in line with what economic theory predicts.

How Wages Are Determined

Wages are equivalent to the expected increase in revenue an individual’s labor generates for the business, or, equivalently, the amount which is expected to be lost if his or her labor went unemployed.

For example, imagine a restaurant employs 5 cooks who are capable of serving C number of customers per hour, earning E dollars in revenue. One cook wins the lottery and retires to the Bahamas, and now the restaurant is only capable of serving C-L customers, and consequently only earns X in revenue. Clearly, entrepreneurs will only be willing to pay the difference between E and X, a number which will be called W, to employ a fifth cook. W is what economists refer to as the marginal revenue product, and, thanks to competition in the labor market, wages tend towards this number in a free market, less a discount for time preference.

To see how taxation effects wages, imagine if every time the restaurant owner goes to deposit his firm’s earnings an armed robber stole 35% of the firm’s net income. Disregarding momentarily what that thief does with his loot, whether he builds roads or funds a study of cocaine’s effects on the promiscuity of Japanese quail, the moment the robbery occurs, the restaurant is making less money than before. It immediately renders the firm less efficient, and the money to be imputed back to the factors of production, including workers, is immediately smaller.1 Put another way: the revenue the firm can keep has now gone down, meaning revenue per employee goes down. This pushes wages down, even though, in a free market, the firm would have been willing to pay employees more.