Thursday, February 12, 2015

The Economic Impact of Lowering America's Corporate Tax Rate

Back in early 2014, the Congressional Research Service released a very interesting study that looked at the implications of lowering the federal component of the statutory corporate income tax regime.  In this study, the author, Jane Gravelle, compared the corporate tax rates of other nations to that of the United States and then provided us with an assessment of the economic impact of lowering the tax.  Those who advocate for cutting the statutory corporate tax rate often cite the "fact" that the U.S. top marginal corporate tax rate of 35 percent makes the American economy uncompetitive and that if corporate taxes were cut, there would be a significant inflow of investment into the United States which would stimulate economic growth and create jobs, both of which would create an increase in tax revenue that would more than make up for the loss of corporate tax revenue.  Let's see if Ms. Gravelle's analysis bears up that hypothesis.

In her analysis, Ms. Gravelle assumes that the corporate tax rate is reduced from 35 percent to 25 percent; the ten percent amount is assumed since the U.S. statutory corporate tax rate is about 10 percent higher than the weighted average of the statutory corporate tax rate of the OECD as shown on this table, noting that the 39.2 percent U.S. rate includes state taxes:

A cut in U.S. statutory corporate tax rates would impact government revenues and output and wages as follows:

1.) Revenues: The Congressional Budget Office projected that corporate tax revenue would be $4.360 trillion from fiscal 2013 to 2022.  If we multiply this by 10/35ths to accommodate the 10 percentage point reduction, the result is $1.245 trillion in lost revenue over the ten year period.  Since some tax credits would change, the author estimates that, over the ten year period to 2022, corporate tax revenue losses would range from $1.3 trillion to $1.7 trillion.

2.) Output and Wages:  Despite the claims that simply cutting corporate taxes will stimulate foreign investment in the U.S. economy, there are other factors at play.  As capital flows into a nation that has a fixed amount of labor, wages are driven up and the rate of return to the investor drops, making the market less attractive.  Work by the author and other economists suggests that output and wages will rise by about 0.18 percent. 

It is also important to note that when the United States reduced corporate tax rates in the Tax Reform Act of 1986, other countries followed suit.  During the period from 1986 to 1988, the U.S. corporate tax rate was reduced from 48 percent to 35 percent with the combined state and federal tax rate dropping from about 50 percent to just below 40 percent.  As shown on this graph, it is quite clear that OECD nations (excluding the United States) followed the lead of the U.S. in reducing their statutory corporate tax rates, thus eliminating the American corporate tax rate advantage:

Odds are very good that, in the current global economy, a cut in statutory corporate tax rates in the United States would be followed very quickly by a corporate tax rate cut by America's economic competitors.

It is also interesting to note that, according to a study by the Economic Policy Institute, in 2012, United States before-tax and after-tax profits as a percentage of national income were a post-World War II highs, coming it an 13.6 percent and 11.4 percent respectively.  One can hardly call that "suffering under a high tax regime".

It is obvious from this analysis that by simply cutting the United States statutory corporate tax rate, the economy will grow and jobs will be created in an environment that is tax revenue neutral is highly unlikely.  A 10 percentage point reduction in the federal corporate tax rate will end up reducing federal corporate tax revenues by up to $1.5 trillion over the next decade at the same time as it results in extremely modest, one-time positive impact on both wages and economic output.  As we all know, Washington will continue to need tax revenue from some source if it hopes to achieve any semblance of fiscal balance and, if tax revenues from corporations are reduced, tax increases from other sectors of the economy are certain to increase and, as shown here, individuals (red line) are already paying an increasing share of Washington's overall revenue: 

1 comment:

  1. As you know it is exceedingly difficult to project dynamic effects on the economy from tax policy changes. One way to assess potential effects is to examine what happened to tax revenues the last time corporate rates were reduced.

    In 1986, when the corp tax rate was 49.8% ,corp tax collections were $83.8b. In 1988, when the lower rate was fully phased in, tax collections were $111.1b. By 1996 they were $190.6b.

    Thus, in 10 years corporate tax collections increased by 127% despite tax rates being reduced by over 10 percentage points--the exact scenario you argue is highly unlikely.

    There is no doubt that the individual tax collections have increased at a faster rate than corp collections. However, this is largely a function of the high corp rate and double tax on corporate profits. Due to these factors there is a tremendous incentive for the formation of partnerships and LLCs to avoid the corp tax.