With the Trump Administration moving towards lowering the corporate tax rate from its current 35 percent, a look at a study by Jane Gravelle at the Congressional Research Service is timely. As almost people are aware, Corporate America likes to complain about the "uncompetitiveness" of the current rate particularly when compared to corporate tax rates in other nations, a factor that they claim is leading to slower economic growth in America. In the study by Ms. Gravelle, she examines the impact of a 10 percentage point drop in the corporate headline tax rate of 35 percent and how this impacts key economic factors including corporate tax revenue, job creation and output.
There are three types of corporate taxes as follows:
1.) the statutory rate - the rate in the tax statute which, in the case of the United States, is a maximum of 35 percent.
2.) the effective rate - the tax rate paid divided by profits - this rate capture the tax benefits that reduce the taxable income base relative to profits.
3.) the marginal rate - the tax rate calculate from the share of pre-tax return that is paid in taxes.
Additionally, in the United States, corporations must pay income taxes at the state level which raises the statutory rate to 39.2 percent from 35 percent.
Let's look at a table which shows the various corporate tax rates for the United States and its OECD peers:
As you can see, the effective corporate tax rate in the United States is roughly in line with its OECD peers. Several other studies show similar results with U.S. effective corporate taxes being similar to those in the world's 15 largest economies including China and Brazil.
Here is a table showing the historical statutory tax rates for the United States and its OECD peers with the weighted column showing the average tax rate weighted to the size of the economy:
Now, let's look at the impact of a 10 percentage point decrease in the statutory corporate tax rate in the United States, a move that would bring U.S. corporate taxes into line with the weighted average of the OECD. Here are the most significant impacts:
1.) Tax Revenue - over a decade, corporate tax revenues would decline by between $1.3 trillion and $1.7 trillion.
2.) Economic Output and Wages - a one-time increase of approximately 0.62 percent at the maximum. Some studies show that the impact on output and wages could be as low as 0.18 percent.
It is interesting to note that, even though corporate tax rates in the United States are higher than in other jurisdictions, total corporate tax revenue as a percentage of GDP has dropped substantially since the 1950s as shown here:
By way of comparison, corporate taxes as a percentage of GDP is around the 3 percent level for other developed economies.
One of the issues that seems to develop when the United States lowers its corporate tax rate is that other jurisdictions follow the American lead. This was the case in the period between 1986 and 1988 when the U.S. lowered its corporate tax rate from 48 percent to 35 percent as shown on this graphic:
When one nation cuts its corporate tax rate, it attracts capital from other nations, however, if all nations cut their corporate tax rates, no nations gain capital and all nations lose tax revenue.
As you can see from this analysis, the idea of reducing corporate taxes in the United States is far from a clear cut win for the U.S. economy. While Corporate America loves to tout the advantages of a lower headline statutory corporate tax rate, this analysis shows that the economy will gain very little at the cost of much-reduced tax revenues. As well, in our "monkey see, monkey do" world, other jurisdictions may simply follow the lead of the United States, lowering their own corporate tax rates in a move to attract business investment. The race to the bottom will clearly lead to a situation where there are no winners except for the corporate world which will see its profits expand.