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Will Tax Cuts Pay Off With Job Creation?

A big selling point for the new tax law was that it would bring a ton of new jobs. Various political factions argue over whether that will really happen. What could go wrong?

Even before the tax cuts, the burgeoning economy, booming finally after years of post-recession sluggish growth, is getting some traction. Oxford Economics, a consulting firm, forecasts that tax reform will add 0.4 percentage points to economic growth in 2018.

Still, several problems are in the wings that could thwart the expansion and with it the chance for more job creation.

These seem irrelevant now. Unemployment, which peaked at 10% in 2009, fell to 4.1% in December. Last year, new jobs were created at an average of 174,000 monthly, not the most rapid tempo but sufficient to absorb the population growth and also chip away at sidelined workers who had given up finding work.

Wage growth has scored a modest rise lately, in accord with the weak increases that have been the norm for years. For hourly workers, the U.S. Bureau of Labor Statistics estimates that pay rose 2.3% in 2017. For S&P 500 companies, which includes white-collar salaries workers, consulting firm Willis Towers Perrin projects a 3.5% average increase this year.

Thanks to the new tax law, the U.S. Treasury Department said that 90% of wage employees are likely to receive higher take-home pay in February, thanks to the smaller bite from their paychecks. That passes along some of the reduced taxes employers will be paying. Credit Suisse estimates that S&P 500 companies will pay $100 billion less to the IRS this year.

Meanwhile, numerous employers are sharing their tax-cut bounty. Companies ranging from JP Morgan Chase to Starbucks to Wal-Mart are giving workers raises. And a lot of them, such as JetBlue, Walt Disney and Wells Fargo, are planning bonuses for their workforces. Certainly, bonuses are less risky for employers to grant, as they need not be re-awarded the next year.

The tightening labor market, which hasn't shown much oomph in bringing higher pay thus far, should finally do so in 2018, according to Joseph Song, U.S. economist at Bank of America Merrill Lynch. In a research note, he pointed out that prime-age workers (25 to 54) have seen their wages climb around 4% annually, back on pace to pre-recession levels. "The trajectory is still gradual," he wrote, “but clearly higher."

On the other hand, three factors could hinder all this, slowing if not stopping any improvements that a strong economy and tax cuts have generated:

Mergers and acquisitions. A number of companies are talking about using their tax-reduction windfall to buy other companies, looking for extra sales and products. While not always true, mergers often lead to layoffs, as new management eliminates duplication and tries to trim waste.

Signs are surfacing that tax-inspired M&A is in the offing. Based on a corporate survey, BofA Merrill Lynch forecasts that the tax bill, particularly the corporate cash it will bring back from overseas, will touch off a new merger boom.

Demographics. Multitudes of baby boomers are retiring - estimated at 10,000 a day. Their departure is a major reason for the decline on the workforce participation rate, now at 62.7% of the population, down from a peak of 67.3% in 2000. Ordinarily, fewer workers in a growing economy would mean upward pressure on wages. That hasn't happened (see next factor: tech). One sure result of the retirement stampede will be a smaller pool for the economy to draw upon. Job creation is tough with fewer people to hire.

Technology. There's an old disagreement over whether the jobs that technology destroys are resurrected in another form. ATMs lead to reduction in bank tellers, but some of them become financial advisors for the bank, using computer tools. Still, in a number of sectors, especially manufacturing, no one is denying that tech has been a job killer. A study by two Ball State professors found that between 2000 and 2010, 80% of factory job losses came from automation.

What if companies use their tax-cut-fueled capital spending to install more robots than hire more people?

Then things won't look so rosy.