Bonus Payouts Are a Reminder That Corporate Tax Rates Matter
In a 2017 CNBC interview, Warren Buffett argued that a cut in corporate federal tax rates wasn't necessary. "We [at Berkshire Hathaway] have a lot of businesses," he said. "I don't think any of them are non-competitive in the world because of the corporate tax rate." Buffett has made many other statements over the years in which he has denigrated the idea that federal corporate tax rates matter when making corporate decisions.
Now comes strong evidence, in the form of the recent bonus payouts (and their timing) to rank-and-file workers employed by America’s largest corporations, that Buffett’s assertion is completely wrong.
The ability of companies to pay out these significant bonuses to employees is certainly explainable in light of the very meaningful recent reduction in the federal corporate tax rate (the marginal federal tax rate for most large corporations has been reduced from 35% to 21%). The newly enacted, lower tax rate will drive large cash savings to corporations in 2018 and beyond. The fact that such meaningful bonuses are being paid by companies is compelling evidence that corporate tax rates matter in corporate decision-making.
Beyond the fact that these companies are voluntarily electing to pay out the bonuses, the speed at which these payments have been announced and paid is primarily a function of the lower tax rates as well. In every instance so far, these bonus payments are being made in advance of the cash flow savings realized by the companies from the tax rate cut. Why is the cut in the corporate tax rate not only funding the bonus payouts, but also causing the companies to pay the bonuses now rather than at the end of 2018 (after the first-year benefit of the tax reduction has presumably been fully realized)? Again, the answer is because corporate tax rates matter. A simplified example explains the tax-related economic incentives and timing considerations at play here.
A company with a December 31, 2017 year-end can deduct, in its 2017 corporate tax return, bonuses paid before March 15, 2018, as long as the bonus plans meet special rules as set forth by the IRS. So, a $1,000 bonus paid in early 2018 would be deducted on the company’s 2017 tax return, generating a $350 reduction in federal corporate taxes (35% marginal corporate tax rate in 2017), and yielding an after-tax cost to the company of $650.
That same $1,000 bonus, if paid after March 15, 2018, would be deductible in the company’s 2018 corporate tax return, generating a $210 reduction in federal corporate taxes (21% marginal corporate tax rate in 2018), and yielding an after-tax cost to the company of $790. So, by deferring the bonus payment to a date after March 15, 2018, the net cost to the company would increase by $140, or over 21%. As such, economic incentives driven by changes in corporate tax rates have hastened the payout of the bonuses, providing further compelling evidence that comparative tax rates matter in corporate decision-making.
Market forces matter as well. Despite predictions from the Left that the corporate tax cut would only benefit executives and shareholders, it is abundantly clear that companies have voluntarily elected to pass on some of the cash savings to rank-and-file workers. They have not done so out of the goodness of their hearts. Rather, they have done so as a competitive tactic to retain their employees in a tight labor market.
Warren Buffett is wrong: corporate tax rates do matter. Progressives are wrong: tax savings generated by corporate tax cuts do voluntarily flow, in part, to non-management workers. This all demonstrates clearly the important lesson that free-market policies, coupled with a low tax environment, best serve the interests of workers, management, and owners (and the overall economy as well).
