Cut profits to pay workers: does it make sense?

The call is going to cut corporate profits to fund higher wages. But is this really a viable option?

This video makes the case for higher corporate taxes to fund higher wages. In a nutshell, higher wages are inflationary unless they are funded by reducing something else. So cut profits, increase wages, and et voila; higher wages, no more inflation.

And this debate lies central to the wave of strikes rocking the UK. But the UK isn't alone; last Autumn, the US saw Striketober,for example.  So expect industrial action to spread worldwide.

And there is a good underlying factor behind this. Just look at the ratio of corporate profits to GDP — the flip side to which is wages to GDP.

In the US, in the second quarter of last year, US corporate profits to GDP hit their highest level ever recorded, with data going back to 1947. This data meant that wages to GDP fell to their lowest level ever.  The ratio of profits to GDP is now at around eleven per cent. To put this in context, in the 1980s, the ratio fluctuated between four and seven per cent.

Does this matter? Well, a well-known Marxist said this: "I've been amazed that after being in a range between four and six per cent of GDP, they (corporate profits) have jumped upward — you would not think this would be sustainable over time."

Apologies, there was an error above. The person who said that isn't a Marxist; it was Warren Buffett — not exactly known for his left-leaning views. He added: "But corporate profits when they get up to eight per cent of GDP, that is very high. So far, they have caused no reaction. One reaction could be higher corporate taxes."

Jumping across the pond, in the UK, corporate profits have increased by roughly 50 per cent in the last ten years. In the first quarter of 2022, they stood at £139 billion. UK GDP was roughly £550bn in that quarter, so the ratio is around 25 per cent. Over the ten-year period when corporate profits increased by around a half, UK GDP increased by less than ten per cent. (Although the comparison with the US is not perfect, the UK data may have been distorted by profits generated by multinationals abroad but reported in the UK, the FTSE 100, in particular, has only limited relevance to the UK economy and data in the US comparing profits to GDP seems to be more readily available. )

So look at it that way, and something seems broken. Corporate profits have been taking up ever-higher shares of the GDP cake; wages have been falling.

If you want an underlying cause of the industrial action breaking out, then the above data is probably it.

Windfall tax

Suppose governments imposed a windfall tax on company profits.

BP made a profit of £5bn in its latest quarter. Just suppose, purely for the sake of argument, those profits were taxed at 100 per cent. That would work out at around £185 per UK household. Of course, no one is suggesting a 100 per cent tax, but then again, BP is just one company.

There is scope to increase corporate taxes to support households.

The case for higher corporate taxes

On the other hand, economic theory suggests that higher corporate taxes lead to lower wages — this does make sense; tax companies more, and they have left money to spend on wages.

But when something appears broken, it needs to be fixed; the steadily increasing corporate profits at a time of low wage growth seems to suggest something is broken.

What about inflation?

The inflation argument is less clear-cut.

As a rule, higher corporate profits to GDP are associated with lower consumer spending.

So, if corporate profits fell and wages rise, consumer spending would rise, and that would push up on inflation. (And by the way, there is massive cognitive dissonance in the inflation discussion right now. Sustained inflation is not caused by wages going up, forcing companies to increase wages; it is caused by wages increasing, leading to excess demand. This ties in with the monetarist argument; that inflation is only ever caused by an increase in the money supply. If certain costs go up, but the money supply is stagnant, and all else is equal, then by definition, other costs must fall. So there is no inflation.)

But there are good reasons to assume inflation will fall dramatically next year. Whilst it is true that lower profits and higher wages would be inflationary, inflation may well fall sharply in 12 to 18 months' time.