Much to like about cutting corporate taxes

 

 

President Donald Trump’s proposal to cut the federal corporate tax to 15 percent from 35 percent has faced much criticism. But broadly speaking — lowering the tax is a good idea.

One reason is that corporate taxation isn’t the greatest way of raising revenue. When you tax a corporation, it’s not just the shareholders who pay. Prices for customers go up to some degree, and take-home wages for employees go down. There’s a chance that some piece of the corporate tax might fall on those who can least afford to pay, specifically low-wage workers. That uncertainty implies that society should shift the tax burden from corporations to wealthy individuals.

There’s also the question of whether corporate taxes reduce investment. In the 1980s, some economists concluded that taxes on capital — of which corporate taxes are one variety — should be zero. Since capital — the physical kind, buildings and machines and so on — allows greater production in the future, taxing it today just means a smaller economy, and therefore a smaller tax base, down the road. That result came from a highly unrealistic model, and later economists showed that when you tweak the model a bit, the optimal corporate tax is no longer zero. Still, the U.S. should be focusing on ways to boost business investment, which has fallen as a share of output in recent years.

There is plenty of evidence that corporate tax cuts can raise investment levels. The U.S. should try corporate tax cuts as one method of getting businesses to spend more.

But perhaps the clearest reason to cut corporate taxes is the waste they generate through avoidance. A key, often overlooked fact about the U.S. corporate tax is that many businesses manage to pay little or nothing. One of the most common ways to do this is to shift profits overseas, through transfer pricing, inversions, or other perfectly legal methods, to a tax-haven country like the Cayman Islands. There, a company can avoid taxes indefinitely, reinvesting the profits in its business and letting them compound. If the company wants to cash out, it has to repatriate its cash and pay taxes to the U.S., but the returns from delaying the date of payment can be substantial. And often, a corporation can avoid taxes altogether by waiting for the U.S. to enact a repatriation holiday. In addition to tax havens, there are many other legal loopholes businesses can exploit to avoid taxes.

As a result of avoidance, the U.S. doesn’t collect much more of corporations’ profits than other countries do, despite having a much higher official tax rate. A number of recent studies find that on average, U.S. companies pay about 27 percent to 30 percent of their profits in taxes, compared with 24 percent to 26 percent average for other nations.

All that avoidance costs real resources — hours of labor by tax accountants and financial professionals, buildings for them to work in, and computers to keep everything in order.

So although we shouldn’t expect corporate tax cuts to be a cure-all, there are a number of reasons to slash the official rate. Most advanced countries have already done this. A rate of 15 percent might be extreme, but a cut to 30 or 25 percent would almost certainly be a good move.

Noah Smith, a Bloomberg View columnist was an assistant professor of finance at Stony Brook University.

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