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Don’t Raise the Corporate Tax Rate

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eye on the news

Don’t Raise the Corporate Tax Rate

If President Biden really wants to raise revenue, there are better ways to do it. April 8, 2021
Politics and law
Economy, finance, and budgets

Democrats have spent the last three years complaining about “excessive” corporate profits. The Biden administration aims to remedy this situation by increasing the corporate tax rate from 21 percent to 28 percent, with the added revenue funding the president’s $2 trillion infrastructure plan. The plan’s top-down approach suffers from serious weaknesses, not least of which is that industrial policy of this kind often doesn’t deliver good results. But even if Biden’s main goal were simply to raise revenue—a reasonable aim, considering America’s rising mountain of debt—increasing the corporate tax rate is the wrong way to go about it.

In 2017, the Trump administration and Congress lowered the corporate tax rate from 35 percent to 21 percent, chiefly because the U.S. charged higher rates than most other countries, putting it at a competitive disadvantage. Unlike personal income, corporate income is easy to move overseas to jurisdictions with lower taxes. The OECD average corporate tax rate is just 23.5 percent; in the United Kingdom, it’s 19 percent, and in Ireland, a mere 12.5 percent. After the U.S. enacted the reduction, there was, as expected, significant repatriation of profits. Biden’s plans include provisions to reduce the incentive to move profits abroad, but the details of how this would work remain fuzzy. It’s extremely difficult to keep companies from moving profits abroad, which is likely why the administration is now demanding a global minimum corporate tax.

The 2017 corporate-rate cut wasn’t just aimed at enticing corporations to move profits back to the United States; it was also supposed to offer other benefits, such as higher economic growth. It has become a pervasive narrative that the tax cut didn’t work because it benefited only rich corporations and failed to boost innovation. But this argument is hard to square with the fact that, following the tax cut, wages—even at the bottom of the income distribution—grew faster than they had in a decade. The tax cut doesn’t get all the credit, since the labor market was already improving, but research indicates that workers partly bear the burden of higher corporate tax rates in the form of lower wages. We should remember, too, that half of all Americans own stocks, so any reduction in corporate earnings hurts them directly.

The argument that the corporate tax reduction didn’t boost investment is also not the slam-dunk case that its proponents believe. Fixed non-residential investment rose after the passage of the tax cut. These numbers were already trending up, so it’s again hard to tease out the exact effect of the tax cut. And the new tax rate was in place for only a few years before the pandemic hit; investment decisions often take place over a longer time horizon.

What we can be sure about, however, is that from now on, investors will be making decisions under a cloud of uncertainty. They’ll have to wonder now whether the tax rate, and thus the return on any investment, will change whenever a new president takes office.

Fans of higher corporate taxes claim that big corporations don’t pay enough—and in some cases pay nothing at all. But this is mostly because the tax system is too complex. Consider the hundreds of potential deductions and loopholes that many corporations (legally) exploit to lower their tax bills. Increasing the corporate rate just adds another distortion to the system, as it makes it more expensive to incorporate. If the Biden administration truly wants to increase revenue and make corporations pay more, it should simplify the maze of deductions, while keeping the rate low.

Photo by Alex Wong/Getty Images

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