Fiscal Policy

Corporate Tax Hikes Would Kneecap the Economy

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Biden wants to make corporations pay their ‘fair share’ at the expense of economic growth.

One of the central questions about the Biden administration’s proposal to raise corporate-income taxes concerns who, between investors (presumably rich) and workers, will bear the cost. While fodder for divisive class warfare politics, this is entirely the wrong question. The issue is how this proposal will affect the economy.

The track record is clear, and there is little disagreement among economists on the immediate effect. Higher corporate-income taxes reduce investment. The chart below compares investment by the private sector with the level of corporate-income taxes relative to GDP, and the strong negative effect is obvious.

Some left-wing economists claim that the corporate-tax cut in 2017’s Tax Cuts and Jobs Act had “no visible effect at all on business investment,” but this is factually wrong.  In 2016–17, before the TCJA, business investment was 13.1 percent of GDP; in 2018–19 it grew to 13.5 percent. All that from a reduction in corporate taxes of just 0.4 percent of GDP, so, effectively, the entire tax cut was invested. U.S. growth accelerated too, from 2 percent in 2016–17 to 2.6 percent in 2018–19.

Results could have been stronger yet had the Trump administration’s yawning deficits been held in check. Investment generally moves in the same direction as government deficits, as deficits reduce national savings. Bigger deficits, less investment — and vice versa. In 2018, the strong investment growth with larger deficits was only the sixth time since the Korean War that investment and deficits grew simultaneously, and it was the largest difference ever between investment growth and deficits.

Back to class warfare, economists on the left claim that “just” 20 percent of the burden of corporate-income taxes falls upon labor. This estimate seems high, given that about 50 percent of the total value-added in production is paid out in compensation and that labor’s factor share is over 60 percent in the U.S. economy. Even at 20 percent face value, though, why boost a tax that indisputably reduces investment and harms labor?

It is evident that investment and jobs are joined at the hip. The chart below shows how closely business investment and employment are related.

Incomes also go hand in hand with investment. The next chart shows how employment compensation is highly correlated with investment.

The positive synergy between investment and income applies globally. The following chart depicts the total stock of capital investment versus GDP, both per capita, for almost every country in the world.

However economists come out on corporate taxes, there is near unanimity that investment benefits an economy and its workers. Economic fundamentals identify four basic sources of economic growth — labor, knowledge, capital investment, and land, including natural resources. They’re not making more land. Labor population grows slowly and needs other sources of growth to increase incomes.  Technological progress generally requires capital investment. In the short to medium term, we must rely on investment to grow the economy, jobs, and incomes.

There used to be bipartisan understanding of investment’s importance. The former Democratic senator, Treasury secretary, and vice-presidential candidate Lloyd Bentsen was, his press secretary told the Washington Post in 1992, “a strong believer in the need to spur investment, to spur savings.” The author of that Post piece also noted that Bentsen had been an “early advocate of a plan to sharply reduce corporate income tax obligations.”

The depth of economic understanding and dedication to the nation’s overall prosperity that once characterized at least part of the Democratic side has now been overwhelmed by “progressive” ideology. Its partisans are engaged, whether as a matter of sincere belief or simple opportunism, in a push designed to secure political advantage by dividing Americans, taking “aim at income inequality,” by targeting wealth both directly and indirectly through the corporate-income-tax hikes, regardless of the adverse economic consequences.

Tax proposals should be evaluated not by their effect on interest groups or income brackets but by their impact on economic growth as a whole. Corporate-tax hikes may hurt the rich, but they also hurt workers, by reducing investment. Economic health and citizens’ welfare should be the goals that matter. There is no moderation in meeting the Biden proposal halfway. The best course is to further cut corporate taxes, moving us from the average of advanced economies to the forefront, to spur, not stifle, our recovery.

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