Is the Trump corporate tax cut working? Is it increasing wages and investment?

This debate has raged ever since the corporate cuts were adopted in December 2017. Unfortunately, these questions have mostly provoked confusion over how the tax law is supposed to work.

The supporters of the tax cut are to blame for much of that confusion. In their zeal to rally public and political support, many predicted that benefits from changes to the corporate tax code — including higher wages for workers — would materialize shortly after the bill was signed into law.

Corporate public-relations departments didn’t help. When the tight labor market led businesses to issue one-time employee bonus payments in late 2017 and 2018, many PR executives decided to credit the tax cuts, adding fuel to supporters’ misguided arguments.

For their part, opponents of the law have also brought little light to our understanding of the law, while adding much heat. They argue that the cuts aren’t working, partly because corporations are not “using” their tax savings “appropriately.” Last month, for example, economist Paul Krugman wrote: “Companies didn’t use their tax breaks to invest more; mainly they used them to buy back their own stock.”

All of this misses the point.

The tax law, which went into effect on Jan. 1, 2018, reduced the corporate tax rate from 35 percent to 21 percent — a 40 percent reduction. The law also allows businesses to write off the full cost of certain investments in the year they are made, rather than deducting them over a number of years. Referred to as “full expensing,” this provision is temporary, and will expire in 2023.

The basic economic argument for how businesses are supposed to react to this is straightforward. The rate cut provides incentives for self-interested companies to earn additional taxable income by allowing them to keep more of it. Businesses respond to these incentives by making additional investments in, say, factories and equipment in the U.S. The full-expensing provision also makes U.S. investment more profitable and therefore more attractive to businesses.

The additional investment will make workers more productive, because they can produce more output with more capital. More productive workers are more valuable to businesses, which will compete for employees more aggressively. This will drive up wages, as employers try relatively harder to retain their existing workers and to attract new ones (both from other businesses and from outside the labor force).

This economic argument undermines claims from supporters and critics alike.

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