January 25, 2018 10:18AM


The success of the corporate tax cut should ultimately be judged by corporate investment levels and wage growth, not share buybacks or one-off bonuses.

Investment is the mechanism through which corporate rate cuts lead to higher productivity and higher compensation, and the Republican plan was explicitly designed to improve the marginal incentive to invest.

Yet announcements made by hundreds of businesses for one-off bonuses for workers and even share buybacks can still be a direct consequence of the tax cut.

There are two economic mechanisms at work here, which John Cochrane has outlined: "incentives" and "cashflow". The former is the more important, but the latter is what we are seeing so far.

Follow the money. Companies have existing investments. The rate cut means they now receive a higher after-tax return than expected, and profitable firms are left with higher after-tax profits.

Each firm will examine how best to use any extra funds. They will know their near-term investment opportunities. Some will invest, and they now have a greater incentive to do so. But if the firm decides not to reinvest, then they may pay out extra cash to shareholders, or to employees in the form of bonuses. They may increase wages too, if they foresee a tighter future labor market, in part caused by the tax cuts.

Of course, some may use the tax cut as a hook to make announcements of wage increases or bonuses that they might have made anyway. It’s a free “good publicity” story, and helps entrench support for lower corporate taxes. But a firm will decide to do what it believes is best for it given its individual circumstances.

There’s a clear mechanism through which the big corporate rate cut leads to short-term bonuses, then. The claim they are due to the tax rate cut is perfectly feasible, and some of the partisan criticism of company announcements is baffling.

Critics are right to say, as I have above, that we should not read too much about the long-term effects of the rate cuts from one-off bonuses. What ultimately matters is how much investment increases, and the whole purpose of the rate cut was to incentivize this.

But if your argument is that it’s investment that matters and we should ignore short-term flows of cash, you cannot in the next breath criticize companies for large share buybacks. In fact, if you care most about investment then share buybacks are probably preferable to one-off worker bonuses. Existing shareholders do not burn the money they receive, and are probably more likely than workers on average to reinvest elsewhere in the economy.

An even worse take though is from those who believe the company announcements are just a timeline effect, completely unrelated to tax. So many people on Twitter say things like “if you’re going to claim all these bonus announcements are due to the tax cuts then Toys“R”Us shutting stores is presumably due to the tax cut too.”

No. There is a clear mechanism through which corporate tax cuts can generate worker bonuses. It's a basic flow of cash. There is no mechanism through which the loss-making Toys“R”Us is affected by a corporate rate cut. Corporate taxes apply to profits, and Toys“R”Us is not making any.