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How Punishing Is the Corporate Income Tax?



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Yesterday, Matt Yglesias had a post arguing that, while the U.S. does have a very high top corporate-income-tax rate, “it’s not actually true that corporate America faces some terrifying tax disadvantage vis-a-vis other countries,” since companies take advantage of numerous breaks and loopholes that other countries generally don’t offer and so don’t really pay that much of the tax.

I think Yglesias raises some interesting issues. It’s true that the U.S. corporate tax rate is very high. Among OECD nations in 2010, the top national statutory corporate tax rates ranged from 8.5 percent in Switzerland to 35 percent in the United States. The picture changes only slightly once we add subnational corporate tax rates to the top national rate.

It is also true that the corporate income tax raises little revenue compared with other taxes (with lower rates), that this share has decreased over the years, and that the U.S. raises less revenue from the corporate tax than the OECD average. Corporations, like individuals, can and do use tax breaks to lower their tax burdens and, as a result, the effective tax rate is lower than the top rate.

However, these breaks shouldn’t be looked at independently of the corporate tax system. As it turns out, the U.S. not only imposes high rates, it also taxes corporations on a worldwide basis: Profits made by an American-owned computer plant are subject to U.S. taxes whether the plant is located in Texas or Ireland. Most major countries don’t tax foreign business income. In fact, about half of OECD nations have “territorial” systems that tax firms only on their domestic income.

I would argue that this worldwide tax system and the high rates together are responsible for the many (not all) tax breaks and the low revenue raised by corporate taxes. A punishing tax system gives corporations incentives to lobby Congress for important tax breaks, and lawmakers are always happy to oblige. If fact, they are happy to oblige even when the tax burden is relatively modest. So, for instance, American corporate profits earned abroad and at home are taxed at a higher rate than in most other countries, so corporations get a “break” on their U.S. tax bill as long as their profits are not repatriated. As a result, many companies are not bringing their profits back to America. It’s legal, and it definitely lowers the amount of tax collected. I am not arguing for higher tax collection, by the way, I am just stating the obvious — not to mention that without these breaks, companies would engage in more tax evasion and there is little doubt that that would have economic consequences.

I understand that the incentive to lobby Congress exists even when taxes are low. As long as lawmakers have the power to grant breaks, subsidies, and special tax advantages, corporations will try to get them. (And as long as special interests ask for tax breaks, Congress will continue to grant many of them.) Yet I have to imagine that the incentive is stronger when the system is more punishing  and the potential gains more important, as is the case with the corporate tax system in America.

The question, then, is why not have a much less punishing corporate tax system (or, better yet, get rid of it) and make sure that lawmakers don’t cave in to special interests? I assume the answer is probably because it’s not in lawmakers’ interests, since they derive much of their power from their ability to redistribute income and grant all sorts of tax breaks and subsidies.

Finally, the idea that we can target a particular group (corporations in this case) with a particular tax is often incorrect, because in most cases we can’t predict who will ultimately pay a certain tax. This is especially true for the corporate income tax. First of all, corporations don’t pay taxes, individuals do. Second, in this case, the individuals paying it are not necessarily the shareholders. In recent years, several much-discussed studies have found that it is likely that much of the burden of the tax is borne not by capital but by domestic labor, in the form of lower wages. For instance, this December 2010 paper by economists Aparna Mathur and Kevin Hassett shows the link between corporate tax rates and the average manufacturing wage (in U.S. dollars) for 65 countries over a period spanning 1981–2005. They find that there is a clear negative link between the two, suggesting that higher corporate tax rates lead to lower worker wages. They test this theory using regressions controlling for a bunch of other factors, and find that a 1 percent increase in the corporate income tax leads to an almost 0.5–0.6 percent decrease in hourly wages.

This is consistent with the results of many recent empirical papers — Arulampalam et al. (2007) , Mihir A. Desai, C. Fritz Foley, and James R. Hines (2007), Felix (2007) — that use real-world data to look at who really pays the corporate income tax. Recent theoretical studies find that between 45 and 70 percent of the cost of the corporate tax is borne by labor rather than shareholders.

Here is CBO’s William Randolph (2006), for instance:

Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax. The domestic owners of capital bear slightly more than 30 percent of the burden. Domestic landowners receive a small benefit. At the same time, the foreign owners of capital bear slightly more than 70 percent of the burden, but their burden is exactly offset by the benefits received by foreign workers and landowners.

In other words, in the quest for more tax revenue and the fight against tax breaks, we should be careful what we wish for, because it’s not clear who ends up footing the bill.

By the way, I agree with this piece by The Atlantic’s Megan McArdle on why we should abolish the corporate income tax.



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