I keep seeing a criticism of the Trump tax plan floating around that demonstrates that corporate profits have grown at a rate of 6.6% this year, versus average wage rates growing at just 3%. While these numbers are true, their representation is false. The fact that people are essentially saying that business owners have kept twice the amount of additional earnings than what they paid out in increases to employees, shows a real lack of understanding of what profits actually are.
Corporate profits are not real. When many people think of corporate profits, they assume it is a number that represents how much hard money a business made after all expenses were paid. They tend to relate it to how they view personal earnings. However, it is completely different. Corporate profits are a fictitious number that represents accounting concepts about how to record money passing through a corporate entity. It’s a lot more about the method of reporting than it is about how much real money is flowing through the company after expenses.
Corporate profits include things that people don’t view as earnings and expenses on their own behalf. For example, people do not deduct the cost of their home from their income for tax purposes. Nor do they deduct their cars for other daily living expenses. Business, on the other hand, has some flexibility in how expenses are deducted and how earnings are reported. The way assets that a business owns are deducted from profits is that they are expensed over time in a manner the government allows, which is called depreciation. As assets depreciate, businesses can choose to use one of a handful of methods to record that as an expense. Even though actual cash is not necessarily going to these costs, they still get deducted. It is actually possible for a business to be making very good money but reporting losses. On the flip side of that, if a business wants to please its stockholders, it can actually be losing money but reporting a profit. It isn’t just depreciation that has this effect, but there are all sorts of accounting methods for reporting various costs, and they differ greatly from country to country and even from State to State. It’s the main reason why accountants have a job.
So, the numbers some people are presenting to show that Trump’s tax cuts on corporations have no effect on personal wages is misleading. Businesses are attempting to report earnings in a more favorable tax environment, which skews the numbers higher. In addition, Trump’s tax plan eliminated some advantages in depreciation costs that also artificially reports higher profits. The real truth of the matter is that whatever corporate profits have been reported don’t really tell us anything about the effects of the Trump tax plan. We can’t really tell from a fictitious number what really happened to the actual money flowing through businesses. Anecdotally, the optimism amongst US businesses seems to suggest things were good. Many businesses are going to benefit more than others, but we really can’t measure the total directly. International corporations can choose further how to report earnings and shift them to whatever country provides them the most reporting advantages. Lowering the corporate rate would, by necessity, increase the number of earnings reported in the US, but it’s very difficult to determine how much, and it does not represent any sort of real increase in earnings. It only represents how things are reported.
So, we can’t tell anything from the statistics, but what does happen when a business gets a greater amount of actual cash flow? What happens when there is an increase in real money flowing through a business? Businesses are like people in the way they handle their money. They can save it, spend it, or invest it. If they save it, it sits in a bank account somewhere, available for lending for both individuals and other businesses. That’s good. If they spend it, it either increases employees’ pay or goes to another business to improve their earnings. That’s good for everyone. If they choose to invest it in real estate, or even in stocks, that represents new capital available for ventures and increased value in assets that helps other investors. That’s a good thing. The economy is not a zero-sum game, where when businesses keep earnings employees lose out. No matter what a business does with its earnings, it always goes to improve the financial well being of everyone in the economy.
So, while we might not know the exact effects of tax cuts to businesses, we do know very well that businesses are not evil for keeping some of their earnings, and it is not to the detriment of employees if wages do not increase at the same pace as increased cash flow. Whenever businesses have an increase in the money they make, everyone always benefits. Whether that benefit is in the form of a direct increase in wages or that benefit comes about through a stronger economy, we all still benefit.