The Obama administration’s proposal to cut the top corporate income tax rate to 28 percent may be a good idea. It purportedly also will eliminate many special provisions and thus broaden the “base” of income that is taxed. Economic theory suggests that reducing the number and scope of such loopholes improves overall economic efficiency.
Reasons for reform are plentiful.
One is that the corporate tax code, like that for individuals, is needlessly complex, with many special provisions that increase the administrative costs of complying with the tax and create perverse incentives for actions that waste resources. (Remember that these loopholes are not random impositions from the Internal Revenue Service. Each was sought from Congress by corporations for their own benefit.) Yet, simplification should reduce compliance costs and improve economic efficiency.
Second, the top marginal rate on corporate income, currently at 35 percent, is nearly the highest in the world. This is said to place U.S. corporations at a competitive dis-advantage relative to firms headquartered in other countries that have lower rates.
This is true, but should be taken with a grain of salt. Corporations in most other countries often are subject to other taxes, especially value-added taxes, that don’t apply here. The overall tax bill of companies operating in the U.S. is on the low end compared with other industrialized countries. And even the marginal income tax rate is higher in Japan, a country that, despite serious economic problems, still has one of the world’s strongest manufacturing sectors.
Our high marginal tax rate is said to discourage U.S. multinational corporations from bringing profits from their foreign operations home to our country, thus reducing capital available for reinvestment in U.S. plants and equipment. This is another case where the theoretical basis is clear, but historical evidence is mixed.
So there are cogent arguments both for lowering the top marginal rate and for eliminating myriad special provisions. But the devil is always in the details. Here are a few to consider:
What would the changes do for the deficit? It is bizarre that in a time when federal tax revenues are at their lowest level relative to gross domestic product in more than 60 years, one of the plan’s claimed advantages is that it won’t make the deficit worse. Why not instead use reform as an opportunity to increase revenues from this tax and help reduce the deficit?
This question is particularly relevant because corporate income tax revenues are near historic lows as a percent of GDP, as a fraction of all federal revenues and relative to corporate profits themselves. At the same time, corporate profits are at all-time highs, both in absolute inflation-adjusted terms and relative to GDP.
A second bizarre feature of the Obama proposal is that while it purports to simplify the code, remove special-treatment provisions and improve economic efficiency, it introduces new special treatment for manufacturing. If you are going to reduce micromanagement of the economy via the tax code, then do so. Don’t reduce special deals with one hand while introducing new ones with the other.
More generally, don’t expect any magic from such reforms in terms of growth in either employment or the overall economy. If the past four decades have taught us anything, it is that while marginal tax rates matter, they are only one of several relevant variables. And a change from 35 percent to 28 percent probably doesn’t matter all that much, especially when the average rate actually paid by most corporations is well below the nominal marginal rate.
Those who claim the Reagan administration’s cuts in marginal rates spurred high economic growth cherry-pick starting and ending years in the 1980s to make the numbers work. But you could make similar claims for any policy change introduced in the trough of a serious recession. Looking at any longer period, economic and employment growth after 1981 was no better than before. And the strongest growth in the post-World War II period was in the 1960s, when both corporate and personal top marginal rates were far higher than now.
Anti-tax zealots will argue the corporate income tax is a bad one that simply should be eliminated. In the end, they argue, all taxes are paid by people, not businesses. Corporate income taxes get passed along to someone. Shareholders may get lower dividends, for example. But customers can end up paying, when the tax is incorporated in the prices of products. In such cases, they say, a corporate income tax is little different from a sales or value- added tax. That is generally true.
Like many other economists, I would be happy to see the corporate income tax replaced by a more economically efficient and more transparent substitute. But those who rail against it don’t want a substitute.
The president’s general idea is a good one, but don’t expect too much.