Paul Krugman has a short wonkish note up on the incidence of the corporate tax. As usual, his analysis is more or less correct. In an open economy, a decrease in the corporate tax can have benefits to workers that exceed the size of the tax cut. Nonetheless, Krugman is skeptical that this policy is relevant:
Finally, a point I’ve been trying to make: what we’re showing here is long-run equilibrium, what happens after enough foreign capital has flowed in to equalize after-tax rates of return. How does that happen? You don’t roll factories across the border: capital inflows take place as the counterpart of trade deficits, which in turn have to be created by a temporarily overvalued real exchange rate.
Long-run analysis is a very poor guide to the incidence of corporate taxes in any politically or policy-relevant time horizon. Over shorter horizons, you’d expect very little of the tax cut to be passed on to workers
First off, I am not sure why long run analysis isn’t a relevant guide. We can get deep into the weeds and talk about recycled profits and payouts to investors also happening over very long timescales, such that it’s not clear that anything meaningful happens to pure owners of capital in the short run. However, there is the simpler point that most of the future will be during and after this adjustment. If we happen to think that future will be better under the tax, that’s meaningful. This is different than the Keynesian argument, which I agree with, that short-term fluctuations in output matter a lot. Here we are talking about gains.
Second, lets take a moment to think about what actually does happen here. Krugman freezes labor supply and internal savings, but it’s not clear to me that these aren’t part of the mechanism by which we reach equilibrium. Let me give a very short, very stylized model of what I have in mind. Corporate tax cut leads to increased equity prices and decreases in bond prices as investors attempt to equilibrate dollar denominated yields. Lower bond prices lead to higher interest rates and higher mortgage rates. Higher mortgage rates lead to less home equity withdrawal. This has the effect of increasing national savings.
That increase in national savings funds an increase in corporate investment. I think that similar channels can work through labor, but I picked this one because I think it is the exact inverse of what we say after the dot-com crash. Decline in corporate investment helped to fund an increase in home equity withdrawal. These internal shifts allow capital markets to equilibrate faster than international flows alone would predict.