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OECD Finds Corporate Taxes Most Harmful to Economic Growth

By: Scott Hodge

In a blockbuster new study titled "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. and Economic Growth," economists at the Organization for International Cooperation and Development studied the effects of various types of taxes on the economic growth of developed nations within the OECD and found that "corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es."

With respect to corporate taxes, the empirical evidence from the new OECD study suggests that "investment is adversely affected by corporate taxation through the user cost of capital", meaning the after-tax return on investment. Looking at the firm-level, OECD economists found that the effect of corporate taxes is strongest on industries that are older and more profitable because of their larger tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. s. Younger and smaller firms (i.e. start-ups) are less effected because they are less profitable.

The OECD 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." ("Tax and Economic Growth," Economics Department Working Paper No. 620, July 11, 2008. Organization for Economic Cooperation and Development. P. 9.)

The main recommendation of the study is that if countries want to enhance their economic growth they would do well to move away from income taxes – especially 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. es – 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 study is particularly timely in light of the new OECD rankings of corporate taxes among the 30 OECD nations. It shows that the U.S. continues to have the 2nd highest overall corporate tax rate among industrialized countries. Only Japan has a higher overall rate.

Worst of all, since nine countries cut their corporate tax rates this year, the overall OECD average fell by a full percentage point, from 27.6 percent to 26.6 percent. This means that the U.S. rate is now 50 percent higher than the OECD average. This should be a wake up call to Washington that our long-term economic health is in jeopardy as long as corporate rates remain so far out of step with our major economic competitors.