The Corporate Income Tax is Most Harmful for Growth and Wages

One of the biggest debates in economics has been the question of who bears the real economic burden of corporate taxes: shareholders through lower returns, consumers through higher prices, or workers through lower wages. In an essay (here) in today’s Wall Street Journal, economist Kevin A. Hassett and Aparna Mathur review the growing empirical evidence showing that workers bear the true economic burden of the corporate income tax through reduced wages.

Since the U.S. not only levies the highest corporate income tax rate in the industrialized world at 35 percent, but has also suffered a decade of stagnant wages, the lesson for American lawmakers is quite simple, say Hassett and Mathur. “These studies and others convincingly demonstrate that higher wages are relatively easy to stimulate for a nation. One need only cut corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rates.”

The evidence shows that the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. is not only harmful for workers’ wages, it is harmful for overall economic growth. In a landmark 2008 study Tax and Economic Growth, economists at the Organization for Economic Cooperation and Development (OECD) determined that the corporate income tax is the most harmful tax for economic growth. Personal income taxes were found to be second-most harmful for growth, followed by consumption taxes, with property taxes found to be the least harmful for growth.

This formulation of “tax harm” makes sense if we consider that the burden of any tax tends to fall on the least mobile factor in the economy. When it comes to corporate taxes, capital is extremely mobile but people aren’t. For example, it is relatively easy for a company to move its operations from Dublin, Ohio, to Dublin, Ireland, to take advantage of that country’s 12.5 percent corporate tax rate. But it is much more difficult for a worker to move his family thousands of miles to follow that job. Thus, the burden of that tax-motivated movement of capital falls on the shoulders of those workers whose jobs may be impacted.

The study also found that statutory corporate tax rates have a negative effect on firms that are in the “process of catching up with the productivity performance of the best practice firms.” This suggests that “lowering statutory corporate tax rates can lead to particularly large productivity gains in firms that are dynamic and profitable, i.e. those that can make the largest contribution to GDP growth.”[1]

The final recommendation of the OECD study is that if countries want to enhance their economic growth they would do well to move from income taxes – especially corporate income taxes – toward less distortive taxes such as consumption-based taxes. The key to creating a growth-oriented corporate income tax system is to impose a reasonably low tax rate with few exemptions.

The GOP “Blueprint” recently released by House Ways and Means Chairman Kevin Brady (R-TX) and House Speaker Paul Ryan (R-WI) would move the U.S. tax code strongly in the direction of what OECD economists recommend. The Blueprint overhauls the corporate tax system, changing it into what is known as a “destination-based cash-flow tax.”

As Kyle Pomerleau and Stephen Entin explained on these pages last June (here), there are five basic components of this shift to a new corporate tax code:

1. The corporate tax rate would be lowered to 20 percent.
2. Businesses would no longer need to depreciate capital investments. Instead, they will be able to fully write off, or expense them, in the way in which they purchased them.
3. The system would be changed from our current worldwide system to a territorial form of taxation. Businesses would no longer need to pay tax to the IRS on profits they earn overseas.
4. Businesses would no longer be able to deduct interest as a business expense.
5. The corporate tax would be “border adjusted.”

According to the Tax Foundation’s Taxes and Growth Model, the GOP plan would significantly cut the cost of capital, which would lead to 9.1 percent higher GDP over the long term, 7.7 percent higher wages, and an additional 1.7 million full-time equivalent jobs.

Hassett and Mathur conclude their essay with the dire prediction that “wage growth will continue to be disappointing as long as the U.S. has the world’s highest corporate tax rate. Denying the need for lower corporate tax rates may be effective populism, but it is causing real harm to American workers.”

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