Recent Changes in Wages and Profits

...the recent decline in employee compensation, from 73 percent of national income in 1992 to 72.2 percent of national income in 1996, is not unusual.

The spectacular rise in the U.S. stock market and recent changes in the share of labor in U.S. national income have stimulated speculation about whether the U.S. economy has entered a "new era" of higher corporate profits funded by a decrease in the share of national income accruing to labor. In The Rate of Return to Corporate Capital and Factor Shares: New Estimates Using Revised National Income Account and Capital Stock Data (NBER Working Paper No. 6263),Research Associate James Poterba uses new Bureau of Economic Analysis estimates of physical assets to examine the behavior of rates of return and factor shares from 1959 through 1996.

Based on the historical evidence, he concludes that the recent decline in employee compensation, from 73 percent of national income in 1992 to 72.2 percent of national income in 1996, is not unusual. Neither is the unanticipated increase in the pretax return to nonfinancial corporations' assets, from 7.4 percent in 1992 to 9.9 percent in 1996.

Since 1959, employee compensation and proprietors' income, the broadest measure of labor's share of national income used in the study, has ranged between a high of 83.1 percent (1973) and a low of 79 percent (1970). The 1996 value, 80.6 percent, is well within this range. The share of wages and salaries has shown a steady decline from 62.8 percent in 1959 to 58.9 percent in 1996, with a high of 65.6 percent (1970) and a low of 58.6 percent (1984). But this merely reflects the increasing importance of non-wage benefits like health insurance and retirement plans in employee compensation. Overall, the share of employee compensation rose from 67.9 percent in 1959 to 72.2 percent in 1996 with a high of 74.1 percent in 1982 and a low of 67.5 percent in 1965.

In a cautionary note, Poterba explains the dangers of looking at one or two years of data in isolation. In 1992, employee compensation was 73 percent of national income, the highest fraction since 1983. Subsequent decline was therefore consistent with historical patterns. Furthermore, increases in the employee compensation share of national income have historically been associated with an increase in civilian unemployment. Given the fall in civilian unemployment from 7.5 percent in 1992 to 5.4 percent in 1996, it would not have been surprising if the decline in labor share had been larger than the observed 0.8 percent.

Similarly, Poterba finds nothing historically unusual in recent pretax returns on corporate capital. Though they jumped from 7.3 percent in 1991 to 9.9 percent in 1996, they remain below the 1960-9 average rate of return of 10.3 percent. Moreover, with the exception of Japan, since 1990 the rate of return on capital has risen in all of the G-7 nations and rates of return in the United Kingdom, Canada, and Italy have risen faster than those in the United States.

The study presents new estimates of the pretax and aftertax returns on corporate capital for 1959-96. The pretax return averages 8.5 percent over this period. The aftertax return, which is net of corporate income and property tax payments, an estimate of investor-level taxes on corporate interest and dividend payments, and capital gains, averages 3.9 percent. This implies an average tax burden of 54 percent for 1959-96. This tax burden includes an average 30 percent for corporate income taxes, 10 percent for corporate payments of property taxes, and 14 percent for investor-level taxes.

Poterba finds some evidence of a recent increase in the average aftertax return to investors. At 5 percent in the 1990s, it was 60 basis points more than the previous high of 4.4 percent in the 1960s. Poterba calculates that the total tax burden on corporate capital income, as a share of pretax returns, declined from an average of 64 percent in the 1970s to 42 percent in the 1990s. This change was attributable to various factors, including reductions in the statutory tax rates on corporations and individual investors, and lower inflation rates.

The largest changes in corporate tax burdens occurred between 1970 and 1985, with the estimated average tax rate declining from 33.5 percent in the 1970s, to 23 percent in the 1980s. Relief for individual investors came later. With marginal tax rates on investment income reaching 70 percent in the 1970s, the investor tax-burden peaked at an estimated 25.2 percent of pretax earnings in 1980. By 1990 it was 13 percent. Falling inflation, declining marginal tax rates, and a growth of asset ownership in tax-deferred forms combined to produce an average tax burden of 10.8 percent for 1990-6.