Last week, The New York Times published a chart showing that corporate tax revenues have fallen significantly since passage of the 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. Cuts and Jobs Act (TCJA). This has led some to wonder whether the dynamic revenue effects that were promised by supporters of the TCJA are going to materialize. If the economy is supposed to grow in response to a tax cut, thus boosting the tax base, shouldn’t corporate tax revenues stay relatively constant, or at least not fall too significantly?
The answer is no. Leaving aside possible micro-dynamic (behavioral) responses by taxpayers, there is little reason to think that corporate tax revenues would not decline by as much as a conventional estimate implies, even if the economy grows in response to the tax cut.
To the extent the federal government gains revenue from additional economic output to offset the initial revenue loss of a corporate tax cut, it will be through increased individual and payroll taxes, not through steady or increasing corporate income tax revenues.
To illustrate, let’s assume the federal government cuts 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. rate from the current 21 percent to 16 percent, a 5-percentage-point reduction. This would be a significant tax cut. Using the Tax Foundation model, I estimate that this would reduce federal revenue by $916 billion over the next decade on a conventional basis, or without any macroeconomic feedback (Table 1).
At the same time, a corporate tax cut will increase the incentive for companies to invest and increase the size of the capital stock and boost economic output (GDP) over the next decade. I estimate that, on average, GDP will be 0.3 percent higher than otherwise.
The larger economy over the next decade means that a 5-percentage-point reduction in the corporate tax rate will reduce revenue by $757 billion on a dynamic basis compared to its conventional cost of $916 billion. This is a revenue feedback of $158.5 billion, or an average of $15.8 billion a year.
However, this revenue feedback is not due to additional corporate tax revenue. Rather, it is due to higher tax collections from all other federal taxes. Corporate tax revenue on a dynamic basis ($914.4 billion) is effectively the same as it is on a conventional basis ($915 billion). The intuition here is that the larger economy does mean that corporations are making more sales, but it also means that they are investing more and, thus, taking even more deductions against their taxable income. In this case, we are estimating that the capital stock will grow faster than GDP and be 0.5 percent larger over the budget window compared to 0.3 percent for GDP (Table 2). On net, this means that corporate taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. will be roughly steady over the budget window.
| in Billions of dollars | ||
|---|---|---|
| Conventional | Dynamic | |
| Individual Income Taxes | $0.0 | $101.6 |
| Payroll Taxes | $0.0 | $46.4 |
| Corporate Income Taxes | -$915.9 | -$914.4 |
| Excise Taxes | $0.0 | $3.6 |
| Estate and Gift Taxes | $0.0 | $0.9 |
| Other | $0.0 | $4.5 |
| Total | -$915.9 | -$757.4 |
| GDP | 0.29% |
| Wages | 0.24% |
| Capital Stock | 0.53% |
| Corporate Revenue | 0.30% |
Dynamic revenue feedback from economic growth is due to higher revenue collections from the income, payroll, and other taxes. The larger economy drives an increase in capital income, wages, and salaries, which boosts tax collections from those taxes. The model estimates that wages will be 0.24 percent higher on average over the budget window. As a result, the individual income tax ends up collecting $101.5 billion more over the decade, and the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. collects an additional $46.4 billion. All other taxes collect the remaining $9 billion due to higher output.
It is worth noting that in terms of the TCJA, the federal government will still lose individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. revenue, on net, even with a larger economy. This is because individual income taxes were cut significantly.
There are also noneconomic factors that could influence corporate tax collections that are worth mentioning. For example, a lower statutory corporate tax rate could make it more attractive to shift profits to the United States. Additionally, a lower statutory corporate tax rate could make it more attractive for noncorporate businesses (pass-throughs) to reorganize as traditional C corporations. Both of these “behavioral” effects would boost corporate revenues and lead to a smaller revenue loss than a simply “static” score would imply. However, they are separate from the pure “dynamic” or economic effects and are generally captured in both conventional and dynamic revenue estimates.
Many people are watching federal revenue collections closely after the passage of the TCJA. The big question is whether the TCJA will deliver the economic gains and revenue feedback that were projected. At this point it is probably too soon to tell, but it is important to understand what to expect. Our modeling suggests that corporate tax revenue will remain low while additional individual income and payroll tax revenue will offset some of the initial revenue loss.
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