Do Corporate Tax Cuts Promote Firm Growth and Higher Earnings?

Kennedy et al. (2026) examine how corporate tax cuts affect firms and workers. They use employer-employee matched federal tax records covering 49,235 U.S. firms and 231,360 firm-year observations surrounding the 2017 Tax Cuts and Jobs Act. They find that larger tax cuts increased firms’ investment, employment, payrolls, sales, and profits. Capital increased 4.6%, employment 1.3%, and payrolls 2.0%. Earnings gains, however, were concentrated near the top: average earnings rose 0.7%, earnings at the 95th percentile rose 1.2%, and executive earnings rose 2.6%. Overall, 87% of income gains accrued to the top 10% of earners.

Why This Article Was Selected for The Policy Scientist

Corporate tax policy is important because it can affect investment, business expansion, employment, wages, government revenue, and the distribution of economic gains across households. These questions remain timely as policymakers continue debating the appropriate taxation of corporate income and the longer-run consequences of major tax changes. This study makes an important contribution by linking unusually rich administrative tax records for firms and workers and by extending influential research on corporate-tax incidence to the full earnings distribution. Its event-study and instrumental-variable designs provide credible causal evidence, a substantial methodological strength. The findings should generalize most readily to large advanced economies, although exclusions of very small firms and the largest public corporations limit broader applicability.

Full Citation and Link to Article

Kennedy, P. J., Dobridge, C. L., Landefeld, P., & Mortenson, J. (2026). Corporate tax cuts, firm growth, and workers’ earnings. American Economic Review, 116(9), 3380–3422.

https://www.aeaweb.org/articles?id=10.1257/aer.20240404

Central Research Question

The study asks how reductions in corporate income taxes affect firms, workers, and the distribution of economic gains. More specifically, it examines whether corporate tax cuts stimulate capital investment, employment, payrolls, sales, and profits, while also determining who ultimately receives the resulting increases in private income. The empirical setting is the 2017 Tax Cuts and Jobs Act (TCJA), which reduced the federal corporate income tax rate for C corporations from 35% to 21%, while S corporations experienced substantially smaller reductions in their effective marginal tax rates. This divergence allows the researchers to examine whether firms receiving larger tax reductions changed their behavior differently from otherwise similar firms receiving smaller reductions.

A second major question concerns tax incidence. Even if corporate tax cuts increase business activity, those gains may accrue differently to firm owners, executives, highly paid employees, and typical workers. The study therefore evaluates both the aggregate economic response to lower corporate taxes and the distribution of those benefits across the income distribution.

Previous Literature

The research builds on a long literature examining how taxation affects investment, business activity, and the division of the corporate tax burden between owners and workers. Hall and Jorgenson (1967) established an influential framework linking taxation to the user cost of capital and firms’ investment decisions. Earlier empirical studies, including Cummins et al. (1994, 1996), examined investment responses using aggregate or firm-level panel data.

More recent research has increasingly relied on policy variation and administrative microdata to strengthen causal inference. Suárez Serrato and Zidar (2016) use variation in state corporate taxes to estimate how corporate tax changes affect business activity, workers, and firm owners. Fuest et al. (2018) examine municipal corporate taxation in Germany and find that workers bear a substantial portion of corporate tax increases. Giroud and Rauh (2019) analyze how state business taxes affect firm activity across jurisdictions. Yagan (2015) provides an especially relevant methodological precedent by comparing C and S corporations in studying dividend taxation.

The study also builds on research examining specific investment incentives, including Zwick and Mahon (2017), House and Shapiro (2008), and Ohrn (2018, 2023). More recent work by Risch (2024) analyzes how tax changes affecting S corporations are distributed between owners and workers. Chodorow-Reich et al. (2025) independently examine the TCJA using confidential tax records and report investment responses similar to those found here.

The contribution is distinctive because it combines firm and worker administrative records, directly observes profits and shareholder outcomes, and estimates effects throughout the worker earnings distribution rather than concentrating solely on average or median wages.

Data

The researchers construct a panel of employer-employee matched federal tax records covering tax years 2013 through 2019. Ending the analysis in 2019 avoids the substantial disruptions produced by the COVID-19 pandemic. The primary firm data come from the Internal Revenue Service Statistics of Income corporate files, which contain stratified random samples of C corporation and S corporation tax returns.

The final analysis includes 49,235 unique firms and 231,360 firm-year observations. Firms must have at least 10 employees, annual sales between $1 million and $10 billion, positive capital, and positive costs. The analysis excludes publicly traded companies, firms with substantial foreign sales, companies switching between C and S status during the study period, very small firms, and the largest firms at the extreme upper end of the sales distribution. Consequently, the sample represents a substantial portion of the corporate economy but does not cover every type of business.

Corporate tax returns provide information on sales, costs, taxable income, taxes, profits, capital investment, dividends, and other firm characteristics. These records are linked to individual W-2 filings to measure employment, payroll, and annual worker earnings. Individual income-tax records also provide information about owners of S corporations. The matched structure is particularly valuable because it permits simultaneous examination of firms, shareholders, executives, and workers.

Methods

The central empirical strategy is a quasi-experimental event-study design comparing C and S corporations before and after the TCJA. C corporations received a substantially larger tax reduction than S corporations. The researchers compare firms within the same industry and employment-size category while including firm fixed effects and industry-size-year fixed effects.

The causal interpretation depends primarily on parallel trends: absent the tax reform, comparable C and S corporations would have experienced similar changes in outcomes. Pre-TCJA trends are generally similar, providing empirical support for this assumption. The design follows the logic used by Yagan (2015), although corporate status itself is not randomly assigned.

The researchers supplement reduced-form event studies with two-stage least squares instrumental-variable estimation. Preexisting C-versus-S corporate status instruments for changes in the net-of-tax rate. This allows the authors to estimate elasticities describing how strongly firm outcomes respond to corporate tax rates.

Numerous robustness checks examine alternative fixed effects, weighting procedures, balanced samples, different outlier treatments, anticipation effects, industry composition, tax shifting, exposure to the U.S.-China trade war, and other provisions of the TCJA. A separate market-level instrumental-variable analysis tests whether broader wage effects might occur across states or state-industry labor markets rather than only within affected firms.

Findings/Size Effects

The larger corporate tax reduction produced substantial changes in firm behavior. Relative to comparable S corporations, C corporations increased their capital stock by approximately 4.6% and their net investment rate by 2.6 percentage points. Payroll increased approximately 2.0%, while employment increased approximately 1.3%.

Business activity also expanded. Sales increased approximately 2.7%, equivalent to roughly $4.4 million annually for the average C corporation in the sample. Costs rose by approximately 1.9%, while pre-tax operating profits increased by approximately 2.3%. Taxable income increased approximately 5.9%. The estimated elasticity of taxable income with respect to the net-of-tax corporate rate is 0.70.

After-tax gains were substantial. After-tax operating profits increased approximately 2.9%, after-tax taxable income increased approximately 9.1%, and dividend payouts increased approximately 16.2%.

Effects on workers were considerably more uneven. Average employee earnings increased approximately 0.7%, but median earnings showed essentially no change, with an estimated effect of -0.2%. Earnings at the 95th percentile increased 1.2%, while compensation for the five highest-paid workers within firms increased approximately 2.6%. Market-level estimates similarly provide little evidence that corporate tax reductions increased median wages throughout broader labor markets.

The distributional estimates are particularly notable. For C corporations, approximately 60% of the private income gains accrued to firm owners, 8% to executives, 32% to other highly paid workers, and essentially none to workers in the bottom 90% of the wage distribution. When ownership and labor income are combined, approximately 33% of gains accrued to the top 1%, 55% to those between the 91st and 99th percentiles, and 13% to the bottom 90%.

The estimated marginal value of public funds is 1.47, implying that each $1 of forgone corporate tax revenue generated approximately $1.47 in aggregate private income within the study’s framework. The researchers caution that this estimate may represent an upper bound if broader general-equilibrium adjustments reduce the aggregate response.

Conclusion

The evidence indicates that reductions in federal corporate income taxation materially affected firm behavior in the short run. Firms receiving larger tax cuts expanded capital, employment, payroll, sales, and profits relative to otherwise comparable firms receiving smaller reductions. These results support the proposition that corporate taxation influences real business decisions rather than merely changing accounting outcomes or the timing of reported income.

The distribution of those gains, however, was highly concentrated. Typical workers experienced little detectable increase in earnings, while firm owners, executives, and highly paid employees received most of the additional private income. Thus, the study simultaneously finds substantial firm-growth responses and highly unequal short-run incidence.

Several limitations qualify the conclusions. The analysis ends in 2019 and therefore measures relatively short-run responses. Extremely large publicly traded corporations and very small firms are not represented in the principal sample. The estimates also do not incorporate potential consequences of deficit financing, changes in government spending, consumer prices, or longer-term general-equilibrium adjustments. Even with these limitations, the combination of administrative microdata, employer-employee matching, event-study evidence, and instrumental-variable estimation provides unusually detailed causal evidence on both the economic and distributional consequences of corporate taxation.