Even the best ideas can be undercut by overselling. A classic case: President Barack Obama’s pledge that if his stimulus bill were passed, unemployment would not exceed 8 percent. Now the same mistake is being made with excessively optimistic claims about tax reforms.
I’m all in favor of simplifying our nation’s tax code in general and closing loopholes in the federal corporate income tax in particular. Many Republicans and many Democrats, including Obama, are in agreement on this. But given the large structural budget deficits we are in, I don’t agree that any extra revenue from closing loopholes should be used to reduce the marginal rate. The general idea of simplifying taxes is a good one, however. Just don’t oversell its possible effects.
A McClatchy Newspapers story, published on the front page of this newspaper on June 6, did just that. The article described effects of the Tax Reform Act of 1986. It asserted that, “It also increased corporate tax revenue flowing into the Treasury by 34 percent.”
Separating out the effects of tax law changes is complex. But ascribing this increase solely to the 1986 act is a clear distortion of history.
Taxable corporate profits are much more volatile than personal income, causing large swings from year to year in revenue from the federal corporate income tax. In the 1970s, for example, these revenue fluctuated from roughly $150 billion to about $200 billion per year, adjusted for inflation to 2010 dollars. But from a high of $203 billion in 1978, they fell to $82 billion by 1983.
A small fraction of this drop was due to cuts in tax rates under the Carter Administration and to cuts for very small corporations in the first Reagan tax bill.
Most of the drop, however, was due to the harsh double-dip recessions of 1980-82 that dramatically depressed corporate profits. As the economy recovered, so did such profits and so tax revenue rose. But when the 1986 act was passed, these tax revenue were still down more than a third from the average for 1977-79.
Yes, the 1986 act did simplify the corporate income tax and did close many loopholes. It did lower the top marginal rate from 46 percent to 40 percent for 1987 and to 34 percent thereafter. And tax revenue, before adjustment for inflation, did increase 33 percent from Fiscal Year 1986 to FY 1987. (Adjusted for inflation, revenue jumped 28 percent.)
Even then, those 1987 revenue were still 20 percent below the levels of a decade earlier. Moreover, it wasn’t took until 1994 that they surpassed those 1978 levels. So to claim that a combination of lowering corporate income tax rates and closing loopholes resulted in some dramatic increase in tax revenue is simply not true.
This is particularly evident when one looks at such revenue compared with the overall economy. During the 16 years it took for revenue to regain the inflation-adjusted level they had been at in the middle of the Carter administration, the overall economy had grown by 56 percent.
Therefore, as a proportion of GDP, corporate income tax revenue fell from 2.6 percent to 2 percent. This decline continued an existing trend. The corporate income tax had averaged 4.7 percent of GDP in the 1950s, 3.6 percent in the 1960s and 2.5 percent for the 1970s. For the 1980s it was only 1.6 percent.
The share of all federal revenue coming from the corporate income tax also declined in the 1980s, from 15 percent in the 1970s to 10 percent in each of the three succeeding decades.
Liberals are wont to decry this as a shift of the tax burden from business to families. This is not necessarily true since the corporate income tax is eventually borne by individuals somewhere, whether corporate executives, shareholders, executives, other employees, suppliers of inputs or consumers.
Conservatives charge that all of the tax is immediately passed along to consumers. This is as much a fallacy as the liberal assumption that it all falls on some small band of plutocrats. Much is, but much is not.
This question of the “incidence” of the corporate income tax – whose income does the tax actually reduce? – is a complex one. The answer varies from industry to industry and even from company to company. The variability and unpredictability of the burden of the corporate income tax, combined with the distorted incentives in the code’s many provisions, is one reason many economists favor abolishing it and instituting a value-added tax instead. That would improve both economic efficiency and fairness, but it doesn’t have a snowball’s chance in hell of happening in the current political environment.
The best we can do right now is to reform the taxes we have. The recent bipartisan commission on deficit reduction outlined possible improvements. Public-finance economists from both parties could suggest many more. This is something we should do. But don’t expect reform to work any miracles in our economy.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.