Each dollar (per worker) of static tax losses raises wages by [more than one dollar] It’s always greater than one… A number greater than one does not mean you’re a moron, incapable of addition, a stooge of the corporate class, etc.
This is also a lovely little example for people who decry math in economics. At a verbal level, who knows? It seems plausible that a $1 tax cut could never raise wages by more than $1. Your head swims. A few lines of algebra later, and the argument is clear. You could never do this verbally.
For the other side of the controversy, see Mark Thoma.
Let me swindle you with the following example.
1. We have the GDP factory, with two workers, A and B.
2. Each worker faces a different tax rate on wages.
3. The pre-tax wage of worker A is fixed. It cannot change.
4. (a) Each worker stays fully employed. (b) That means that the ratio of the marginal product of worker A to the marginal product of worker B must remain constant.* (c) That means that the ratio of the after-tax wage of worker A to the after-tax wage of worker B must remain constant.
*That ratio is completely determined by the production function, which is given, and by the quantities used of the two workers, which are fixed at full employment.
OK, now we cut the tax rate for worker A. What happens to the pre-tax wage of worker B?
At the fixed pre-tax wage of worker A, the after-tax wage for worker A goes up. Because of 4(c), that means that the after-tax wage of worker B must go up. The only way that can happen is if the pre-tax wage of worker B goes up. And to get worker B’s after-tax wage to go up by, say $1, you have to raise worker B’s pre-tax wage by more than $1. So worker B gets a big raise.
Substitute “capital” for worker A, “the interest rate” for worker A’s wage, and the corporate income tax for worker A’s tax rate, and I think you have the story that everyone is talking about.
But this is a swindle. We have fixed both the quantity and price of worker A. Taking worker A to be capital, the fixed supply is plausible because you think “how can we instantly adjust the supply of capital?” The wage, er, interest rate is fixed because, well, we know that the world interest rate is given, right?
But it cannot be right. A fixed wage suggests a perfectly elastic supply. A fixed quantity suggests a perfectly inelastic supply. There is a contradiction between 3 and 4(a).
The larger issue is that the simple model of a GDP factory with two factors of production and full employment is just silly. And even though other models add enough complexity to require computers to solve, they are also just silly.
There are many types of capital, which is what creates all of the lobbying and infighting over corporate taxes to begin with. There are also many types of labor, which substitute for and complement with the various types of capital in different ways. Adjustment takes time, and not all types of capital and labor are continuously employed. Over time, there is innovation, some of which is exogenous and some of which is in response to the tax change. The supply of each type of capital and each type of labor is neither perfectly elastic nor perfectly inelastic (and certainly not both!).
The moral of the story, in my view, is that forecasting the impact of economic policy is not a science. We know that, but then people demand a forecast, and they turn to a CBO “score” as if it were the final word on the subject. I have a forthcoming essay on the mis-use of CBO scores.