Health care reform is incredibly challenging because there will always be winners and losers from any change. Tax reform is similarly difficult because inevitably some will pay more and others will pay less with any given plan. “Fairness” simply lies in the eyes of the beholder when constructing these types of reforms. But when it comes to the corporate tax there are no such tradeoffs, which is why we were happy to see the Trump Administration release an outline today that would slash rates for businesses.
“Under the Trump plan, we will have a massive tax cut for businesses and massive tax reform and simplifying the system is what we’re going to do,” Treasury Secretary Steve Mnuchin said of the plan. “As the president said during the campaign, we will lower the business rate to 15 percent.”
That massive rate reduction was no doubt the headliner, but the details, which include the move to a territorial tax system, in which companies are only taxes based on what they earn in the U.S., and a one-time tax on overseas profit, which will encourage repatriation of cash currently locked overseas, are enormously important in their own right.
All of these are much-needed reforms that will allow the U.S. to become more globally competitive, but more importantly, they are likely to provide an enormous boost to workers.
The United States currently boasts the highest corporate tax rate—35 percent—in the developed world, which creates a tremendous economic disadvantage for domestic companies. When combined with the state statutory corporate tax rates, the average rate is 39.1 percent, about 14 points higher than the OECD average of 24.8 percent. Of course, very few corporations actually pay the top rate, in no small part because they’ve worked to create and exploit various loopholes in the tax code to drop their effective rate.
This is the worst of both worlds. On the one hand, we have an uncompetitive tax rate that incentivizes corporations to move, or at least set up subsidiaries, in lower-tax jurisdictions. But on the other hand, in order to be “competitive” we’ve had to create numerous loopholes, credits, deductions, and other avoidance strategies that create economic distortions that favor some businesses over others.
On top of that, the corporate tax is just fundamentally a bad way to raise revenue.
The economic evidence shows that the corporate income tax is harmful to both overall economic growth and workers’ wages, both of which have been growing slower than usual since the 2009 recession. As the Organization for Economic Cooperation and Development found in its landmark study, corporate taxes “are found to be most harmful for growth” of any of the taxes examined, and that “lowering statutory corporate tax rates can lead to particularly large productivity gains in firms that are dynamic and profitable, i.e. those that can make the largest contribution to GDP growth.”
Similarly, research suggests that corporate taxes are significantly related to lower wages. Justin Fox, writing for the Harvard Business Review, explains why:
If a country allows free capital flows and free trade and has a corporate tax rate much higher than that of its neighbors, investors can choose to buy shares in companies elsewhere that face a lower tax, and corporate management can choose to move operations abroad. Consumers, meanwhile, can buy from foreign suppliers. By comparison, workers are pretty immobile. It’s hard for them to switch employers, let alone countries. So the tax lands on them, in the form of lower wages and/or skimpier benefits. And as those at the top of today’s corporate hierarchies seem to have done a pretty great job of keeping their paychecks from being adversely affected, the impact is presumably greatest on those farther down in the organization.
Numerous studies have shown that corporate taxes have enormous impact on wages. For instance, a study by Arnold Harberger found that labor bears 80 percent of the burden of corporate taxation, the Congressional Budget Office found the figure to be 70 percent, an Oxford University study found that a $1 increase in corporate taxes reduced real wages by 92 cents, and a similar study by scholars at the American Enterprise Institute found that for every 1 percent increase in rates, wages decreased by 1 percent.
Taken together that means corporate taxes reduce economic growth and punitively impact wages. There are no downsides here. There are no losers. As Speaker Paul Ryan said of Trump’s plan:
“With an eye toward fairness and simplicity, we’re confident we can rebuild our tax code in a way that will grow our economy, better promote savings and investment, provide our job creators with a competitive advantage, and bring prosperity to all Americans.”
And all it takes is reducing the corporate tax rate.